I was recently having a conversation with a close friend of mine who happens to be a Marine (we are great friends despite the fact that I was in the Army). Now I know what you may be thinking: Who would want to hear investment advice from a Marine? Not to worry, the message is in the conversation not from the Marine!
The conversation centered around the performance of his retirement portfolio over the last four or five years. His annualized returns had been low, and he realized that his retirement portfolio was underperforming others that he knew. He wanted me to take a look at his holdings and see what I thought.
Before I looked at the actual portfolios, I asked him to tell me a bit about his financial advisor, what kind of risk assessment he had done, and how his strategic portfolio was constructed. He said that he and his advisor had talked about the tax-deferred nature of the portfolio and the time horizon being 10 years or more, but, surprisingly, they had never done any sort of formal risk assessment. He also said he was unaware of any strategic portfolio or benchmark for his portfolio. He did tell me that his advisor said, “You can’t outperform the market” and therefore it was important not to try to time the market – so he did know that his advisor was not “churning” his portfolio.
Also surprisingly, when I asked my friend what he meant by “the market” he couldn’t tell me. Is the market the S&P 500? Is it the Russell 3000? Bloomberg US Aggregate Bond Index? MSCI All Country World Index? Some combination of these indices? Unfortunately, none of these choices seemed to ring a bell. I suggested we not lose heart, because if you can’t beat the market, then certainly his advisor would have his portfolio invested in “the market” (since it’s unbeatable). So we would find out what “the market” actually is when we opened up his statement. One of the things that kept bothering me was the potential disconnect between “outperforming the market” and creating a portfolio that would allow my friend to achieve his financial goals. If the advisor narrowly defined “the market” as a single index, it could be possible for my friend to outperform (or perform in line with) that index and still fail to achieve his long-term financial goals.
I was somewhat dismayed when we looked at the portfolio; the holdings were all in one family of relatively high expense ratio mutual funds. It had significant allocations to cash, fixed-income, international, small cap, and value funds. So, it was immediately apparent why the returns were low relative to most major equity indices over the last five years. In fairness to the financial advisor, the portfolio could have been completely appropriate, but we didn’t know what the advisor’s long-term forecasts were for the asset classes in the portfolio, nor did we know how he had classified the level of risk appropriate for my Marine buddy. So at a minimum, there was a significant communication failure between my friend and his advisor. Although the low performance in a retirement portfolio with a more than 10-year time horizon was sobering, we did have a chuckle when we tried to reconcile the statement “you can’t beat the market” with a portfolio full of high expense ratio actively-managed mutual funds.
After we were done laughing, my friend got serious and asked what I thought that he should do about the retirement portfolio. My response was, “You need to find your Interstate 80!” Of course he was puzzled by this, so I explained that our CIO, Paul Jablansky, always says that after you determine what your risk tolerance and tolerance for drawdown is, and you understand the opportunity cost of less risky portfolios versus more risky portfolios, then you go about finding your “Interstate 80 Portfolio.” If you are driving from New York City to San Francisco, you know Interstate 80 will get you there. You may divert around traffic in Des Moines or take an alternate route around Salt Lake City in the winter, but you know Interstate 80 will get you to your final destination. The Interstate 80 Portfolio or Strategic Portfolio is the same concept; it is a portfolio that will allow you to achieve your investment goals over your investment horizon. You may tactically adjust around the portfolio during certain market environments, but the Interstate 80 Portfolio is your anchor.
Of course the discussion next turned to how to construct the Interstate 80 Portfolio. After asking whether he should use the S&P 500 or other widely known index, I asked him to take a step back and think about it a little more “strategically”! First, I recommended that he contact his financial advisor and have a discussion about the appropriate level of risk for his retirement portfolio. What kind of return did he need to achieve his long-term objectives? What kind of tolerance did he have for risk, including both volatility and drawdown? Only when he had identified these things could he begin to construct the Interstate 80 Portfolio.
Now back to what index he should use. It makes sense that if we want to produce the most well-diversified and most efficient portfolio for my buddy’s level of risk tolerance, we should start with the global opportunity set rather than a single index like the S&P 500 or Russell 3000. Why throw out the potential for diversification and higher returns for the same level of risk? Broadly, the investable global opportunity set consists of US Equities, Non-US Equities, US Bonds, Non-US Bonds, Gold (Commodities), Real Estate, Private Markets, and Crypto. Of course many of these categories can be broken down into subsets; for instance Non-US Equities can be broken down into International Equities and Emerging Market Equities, etc. See Figure 1 for the value-weighted composition of the Global Portfolio.
Figure 1
Source: Bloomberg, Goldman Sachs, AAFMAA Wealth Management & Trust
Next, my Marine buddy asked, “So my portfolio should be like the Global Portfolio?” I responded that the Global Portfolio is often used as a starting point, but we know that the Global Portfolio is often not optimal — even over relatively long time periods, and we’d be ignoring any risk requirements or return assumptions that we might have about the asset classes within the Global Portfolio. He next asked about where we get the return assumptions for the assets in the Global Portfolio. “Don’t we just look at the average of the historical returns and assume that each asset class will have an average return in the future?”
We talked a bit about the dominance of US large-cap equities in recent years and the fact that international and smaller cap equities have generally been highly correlated with the S&P 500 but with lower return and higher risk. So they haven’t provided any diversification value with the exception of international equities in 2025. If we used only recent historical return data, we would get portfolios that were heavily skewed toward US large-cap equities.
However, if we want to use historical averages as our forecasts for returns for the next 10 years in the future, what is the time frame used to calculate the historical average? Is it the last year? Last five years? 20 years? 50 years? Are we concerned that the world is a very different place than it was in the 1970’s? The average return and subsequently the weight assigned to the asset within a portfolio can vary dramatically based on the length of time used to define “historical.” I also reminded him how the optimal portfolio changes through time. In the 1950s, the US was 50% of global equity, but then dropped to 30% in the 1980s as Japanese equities surged.
The point is that there is no guarantee that the trend we’ve seen over the last few years will continue. Additionally, using only historical data discards any information that we have currently that might give us insight into the future investment landscape. Are we concerned about the level of debt across the G-7 and its potential impact on government bond returns? Or perhaps the fact that central banks are stockpiling gold reserves as confidence in fiat currencies declines? Or maybe the fact that the US cyclically adjusted price earnings ratio is at an unprecedented level and US equities as a percentage of the Global Portfolio are back to levels last seen during the internet bubble? What about the possibility that we are facing a higher level of steady state inflation? This could factor significantly into what is needed for financial success in retirement. Using only historical data requires us to ignore this information and everything we are currently observing in the investment landscape.
The truth is, there is no single “correct” way to calculate the 10-year (long-term) future expected returns that we use to determine the Interstate 80 or Strategic Portfolio. Most managers use a combination of historical returns as well as future forecasts. The point that I made to my Marine friend is that his advisor should be able to share the return (and risk and correlation as well) assumptions that he made in constructing his portfolio so that he’d be able to reflect on whether the assumptions made sense. I think my friend would have felt much less anxious had he felt confident that his retirement portfolio was being managed at the appropriate level of risk and that he understood the long-term return assumptions behind the portfolio that he was currently holding.
The final part of the conversation took a very different turn. He mentioned that he was going to have to move his mom into a new house nearby and would probably have monthly cash flow requirements to maintain his mother in her new home. “Hold it! You’ve just transitioned this conversation into one about financial planning," I said. "While making sure that your retirement portfolio is properly invested so that you can expect to achieve your long-term financial goals is important, it is only one element in a successful financial plan." Professor Julia Fonseca at the University of Illinois mentioned recently at an Institute for Quantitative Research in Finance presentation on “Optimal Portfolio Choice Over the Lifecycle” that one of the most important actions an individual can take to ensure financial success in retirement is to check in with their financial planner on a timely basis to make adjustments to investments when there are life events. I mentioned this to my friend and said “Marine, I think you’ve just experienced a 'life event!'”
As we approach the new year, take this opportunity to check in with your financial planning team. Remember that a sound financial plan is more than just having a retirement portfolio. Life events can dramatically change the optimal financial plan and making these adjustments in a timely fashion can be critical. These events may also change your time horizon and level of risk aversion for other investment portfolios. Check in with your Relationship Manager and assess whether your risk tolerance has changed. Finally, check in to see if it’s necessary to make a detour around Salt Lake City this winter, and make sure your portfolio stays near Interstate 80!
Best wishes for the holiday season and new year,
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