By Ivan Gruhl, Chief Investment Officer, HK Financial Services
Stephen Hawking, the late renowned theoretical physicist and author, writes in A Brief History of Time: “We could still imagine that there is a set of laws that determines events completely for some supernatural being, who could observe the present state of the universe without disturbing it…. It seems better to employ the principle known as Occam’s razor and cut out all the features of the theory that cannot be observed.”
So, you might ask, “What does this have to do with investing?” Well, let’s talk about Occam’s razor. Sir William of Occam was a 14th-century English philosopher, and his ‘razor’ is a hypothesis, or a theory of parsimony, economy or succinctness. It is a principle urging one to select the simplest of competing solutions.
Our investment world can be a complicated one. We are constantly bombarded with the latest news of a European recession, a fiscal cliff, slow growth in the U.S. and China, unrest in the Middle East, and election concerns, to name a few. Advisors everywhere are full of various advice on the latest ways to outperform the market. The solution: Think of Occam’s razor and keep it simple. Be strategic, diversify and most of all, be realistic.
- Be strategic. Time horizon is a key variable in financial planning. Many believe that as retirement approaches, portfolios need to become more conservative. However, a balanced portfolio can exist for many years with annual withdrawals made as needed. For example, a 5% withdrawal rate can be covered by dividends and interest; small liquidations can support any shortfalls. This is analogous to the ‘endowment model’ adopted by institutions to invest and grow investments into perpetuity, where 5% of annual withdrawals are the norm. Clearly, there is no guarantee that any income strategy can produce the desired income in all market environments, but the objective is to construct a portfolio able to sustain interim volatility, with the goal of higher total returns over the long-time horizon.
- Diversify. Maintain a well-diversified portfolio of growth and income managed to the appropriate time horizon. Incorporate international and emerging market stocks and bonds for additional diversification. Emerging countries represent about 50% of global GDP, and many of these countries are on track to fuel global growth in the foreseeable future. Ideally, your portfolio is structured to meet the cash flow demands for the duration of retirement while providing a lasting legacy for future generations.
- Be realistic. Do not expect historical returns to repeat. Using the bond markets as an example, we have had an unprecedented run in the bond markets in the past 30 years. Since Treasury rates peaked in the September/October 1981 time period at around 15% in the 10-year and 30-year part of the curve, we have seen a secular decline in rates to the current historically low levels. These unusual factors are unlikely to be repeated over the next 30 years, and these returns simply cannot reoccur.
“The rally in bonds is a once in a millennium event, but it’s absolutely mathematically impossible for bonds to get any kind of returns like this going forward … If you missed the rally in bonds, well, then that’s it.”— Jeremy Siegel, Finance Professor – Wharton School at the University of Pennsylvania
Keep it simple: Be strategic, diversify and be realistic in your expectations. The ultimate goal is an efficiently diversified portfolio constructed of income and growth components to provide the maximum potential of total return for a chosen level of risk. 8353602