The Four Questions to Ask Before Adding Anything to Your Portfolio (EP.274)

0:02Peter:We all need to make smart decisions with our money. The Long-Term Investor podcast shows you how by distilling complex financial matters into easily digestible lessons. And now, here's your host, Chief Investment Officer at PlanCorp and the author of Making Money Simple, Peter Lazaroff. Welcome back to The Long-Term Investor. I'm recording live today from Future Proof, the world's largest wealth festival here in Huntington Beach, California. The most exciting thing today, though, was holding my new book, The Perfect Portfolio, in my hands for the first time. It will be available next week, September 22nd.

0:40And at the top of the episode description, there is a link to purchase the book. So if you've enjoyed the show over the years, this is a great way to support me. And I thought today we would just do a quick outline of what is really going on in this book. So the book is organized into three separate parts. The first one is really focused on some of the foundational knowledge that you need to build the perfect portfolio for you. The second section really evaluates different investment strategies because again, I don't think that there's just one universal, one-size-fits-all portfolio that's perfect for everyone.

1:12And so one portfolio or strategy might be good for you and different for another person. And that second section really walks through those nuances. The third section is all about implementation. But all throughout the book, there's a framework that I call the probabilistic decision protocol call that really helps guide whether something should be added to your portfolio or whether you need to make a change. And it's really just four simple questions. It's why do you expect positive returns? Does it meaningfully improve your portfolio? Does it introduce unnecessary complexity? And are you ignoring base rates or extrapolating recent success?

1:48So I go through this framework throughout the book through big examples and small things that are widely accepted like international diversification, and then also topics like private investments where there's maybe some more question marks. I just wanted to dig a little deeper into those four questions just to give you a little preview. Now, in general, I am more concerned with implementing a bad idea than missing out on a good one. And I think these four questions, the way that I will think through an investment decision, really that sort of lens of being more concerned about implementing the bad idea tends to shine through.

2:22So let me give you an example. Like with question one, why do you expect positive returns? Well, typically we're looking for something that's a productive asset, something that generates profits, dividends, interest, rent, or is tied to some well-established risk premium. Those are the fundamental building blocks of long-term wealth creation. Whereas something like gold, let's say, is not a productive asset. It is a speculative asset. Cryptocurrency is a speculative asset. So for me, when I look at something like question one, why do you expect a positive return? If you don't have the right answer to that question, it's really easy to eliminate that from your portfolio.

2:59The second question, does it meaningfully improve your portfolio? When I think about this, there's really only two ways that you can improve your portfolio, quantitatively speaking at least, and that is enhancing return or improving diversification. Throughout the book, we test the different types of investment strategies. And when there are some that are shades of gray as opposed to just being plain black and white, as you go through this framework, it helps you decide what makes sense for you. Now, the third question, does it introduce unnecessary complexity? I think is just such a great exercise to talk through with somebody because complexity is not automatically bad.

3:38And trust me, I prefer simple over complexity, all else equal. However, the keyword is not, does it introduce complexity? It is, does it introduce unnecessary complexity? So there's a lot of great strategies and innovations these days in the investment world that do require you to step out on the complexity spectrum. And so ultimately, I think there's a lot of interesting topics where we get to look through that lens. And finally, the fourth question, are you ignoring base rates or extrapolating recent success? I think this is a really good exercise because when something has been winning, we tend to assume that it will keep winning.

4:14And when something's been disappointing, we assume that it's broken. And both instincts produce the same mistake. Buying what's already popular and selling what is currently lagging. And even in a world with a lot of luck, somebody will always look like a genius. I mean, if there are thousands of funds and strategies in the market, a handful of them are going to have a spectacular three-year run just by chance. Those are the funds that end up in the headlines though, and on podcasts and in pitch decks. The winners are the ones you're always shown, the base rates push back against that. And in simple terms, a base rate's just the long-term record for this type of investment.

4:51And so you might ask yourself, how often has it worked across different market cycles? How often has it failed? What does a normal bad stretch look like? And this question, like many of the others, you might have a shades of gray type response and how you view the world. Like if you're more concerned about missing out on a good idea, you might look at that question a little bit differently than if you're more concerned about implementing a bad idea. And I say it all the time. I've already said it twice now. I am more concerned about implementing a bad idea than I am missing out on a good one. And so that is gonna color the types of investments I'm willing to include, the types of changes I'm willing to accept.

5:28And good investing is not about always being right. It's about making decisions you can live with and sticking with them long enough for the odds to matter. Again, there's a link at the top of the episode description to buy a copy of the book. If you appreciate the work I do for you week in and week out on this podcast, I would be eternally grateful if you would pre-order a copy. Again, The Perfect Portfolio will be released on September 22nd. The link is in the episode description. And as always, thanks for listening.

6:07Peter:answered on the show? Visit thelongterminvestor.com. Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast. Thank you.