Harry Markowitz, the father of modern portfolio theory (MPT), recently passed away. In simple terms, modern portfolio theory attempts to provide a framework to select investments and properly balance risk and return. His work was fundamental to the concept of an “efficient” portfolio.
As professional portfolio managers applied MPT and other research, it became more apparent that certain styles of investing are relatively simple but can still balance risk with a reasonable amount of investment return over time. The investment world has many certifications and licenses designed to regulate and educate financial professionals, but in the last couple of decades, the ability to craft a diversified portfolio that considers risk, return and diversification has become more accessible to the masses than before.
Can investing be simple?
According to Morningstar, the goal of a minimalist portfolio is to use the fewest number of holdings to achieve diversification. Products like broad-market index funds and exchange-traded funds can give an investor with little to invest access to the entire US and international stock bond markets with very low expenses.
Advantages of a minimalist portfolio
Simple to understand: One of Benjamin Graham’s guiding principles of investing is to only invest in businesses you understand. Minimalist investing gives a different take. Pick an investment strategy you understand. What does it mean to understand an investment strategy? It means you know where the money is going, what the risks are, and the potential return for those risks.
For example, if an investor is interested in owning the largest US companies, many funds track indexes such as the S&P 500. The strategy is simply to own the largest US stocks, which some investors would consider a bet on the larger US economy. For a minimalist investor, that means the historical performance of such an index is easy to find and, while you may not be able to predict the short-term performance, the long-term track record has been positive.
This is simple in comparison to many strategies that involve trying to buy things like individual stocks, bonds, and cryptocurrency. To understand what you are doing in those spaces, you need to research the behavior of each investment and its potential risks and returns. If you do your due diligence, you will likely find owning one stock exposes you to a high level of risk so you would need to own more. A minimalist strategy helps you offset the risk of holding just one stock or bond.
Low costs: Another key component to many minimalist portfolios is having low fees. While the costs of buying an individual stock are down, many people find the prospect of researching each individual security to be very time consuming. They may determine it is time to hire a financial advisor to manage the investment selection process.
However, many investors may not have enough assets to manage to walk into their local advisor’s office and hire them. Hiring professional investment management will also come with a cost. It is important to understand the value you are getting for working with an investment advisor because fees can offset your return on investment over time.
There are levels to being a minimalist
While there are definite upsides to owning a minimalist portfolio, it may not be for everyone. The concept of buying a few index funds with no guidance may not be appealing. How do you know if you are buying the right investment for your situation? This is where the work of Markowitz and others comes in.
If your assets are not at a level that merits hiring an advisor, you can pay an advisor for a consultation and they can teach you how to use concepts from modern portfolio theory to measure your risk and help you get started. Also, robo advisors can ask you questions to help you measure your risk tolerance and manage your portfolio at much lower minimums for a fraction of the cost of hiring an investment manager.
If you are investing for a particular goal like retirement, a target date fund can be a relatively low-cost option to help you save as well. Target date funds use the MPT concepts to help place you in a moderate portfolio based on your proximity to your goal. If you are investing for a particular goal like retirement, a target date fund can be a relatively low-cost option to help you save as well. Target date funds use the MPT concepts to help place you in a moderate portfolio based on your proximity to your goal. For instance, a 2040 target date fund tries to balance risk, return, correlation, and diversification to craft a portfolio based on the goal of distributions in the year 2040. You may already own funds like this in your 401(k).
Still have questions about how to get started on your investment minimalist journey? Consider consulting with a qualified and unbiased financial professional as well. Ask your employer if you have access to one for free through a workplace financial wellness program.
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