I came across a great article today that can teach us principles for our financial lives and our lives in general. The article is from an interview with Carl Richards author of The Behavior Gap, (if you haven’t read it, I highly suggest it). The article discusses how focusing on the wrong things can be detrimental to success. This is true regarding our finances and our lives.
Carl argues that the only things we should focus on are the things that are important and in our control. Anything that doesn’t fall into these two categories should not be worried about or focused on. In finance we often focus on our rate of return, but Carl believes there is something else we should focus on that often controls return, volatility. Volatility refers to the amount of uncertainty or risk related to the size of changes in a security’s value. So higher volatility means the investment has the chance to go much higher or much lower than one with lower volatility.
To some volatility may be something they don’t like, or something they don’t want in their portfolio. This may be because their view is too short sighted. In the interview, Carl states, “you should view volatility as risky in the short term, but not risky in the long term.” If we can expand our vision and time-frame volatility is a great thing in our portfolio because it generates bigger returns as long as you wait for the long-term returns to appear.
At MWA there are a few things we think our clients should focus on to create a good investment experience. These include:
- Cost: academia has shown that cost is one of the best determinates of future return. We believe investors should use low cost investment options
- Asset allocation: this means which types of investments you own (equity, fixed income, emerging markets, international etc.) research has shown that asset allocation is 94% responsible for returns
- Diversification: missing the top 10 performing stocks could cost your portfolio 4% annually over a 20-year period, we believe you should own all available in the US, International, and Emerging Markets. More diversification reduces risk and but increases certainty.
- Volatility/Risk: risk and return are related and if we can have a long enough time frame we will be rewarded for the volatility and risk we assume.
In investing, risk and return can be minimized, maximized, or combined to produce a more moderate approach. How a portfolio is designed or structured will have a large impact on the return received. For more information about volatility and focusing on the right things, take a look at Carl’s interview below. Enjoy!