Minimize Your Miss – Portfolio Charts

I have a good friend whose son is an accomplished golfer. Beyond the natural fatherly pride that he feels, there are also moments of awe where a wisdom borne from years of practice sneaks through in ways that you may not expect from such a young person. For example, when asked how he got so good at golf, his son replied with this (paraphrased) all-time gem:

Hole-in-ones are mostly luck, so I don’t fixate on hitting great shots. I practice minimizing my miss.

That’s not just solid advice on the golf course, but also a remarkable philosophy to live by.

It also struck home with me, as my investing philosophy is a little different than what you usually see in popular finance. Promoting trite “5 easy ways to maximize your returns” is a lot easier than explaining nuanced concepts involving uncertainty. But the idea of “minimizing your miss” is a great metaphor that brings the range of outcomes to the forefront. Wise investing isn’t about always swinging for the flag, but staying on the fairway.

The cool thing about working in visuals is that there are a few good ones that demonstrate this investing philosophy particularly well. So let’s hit the driving range and talk about the mechanics and benefits of consistent investing.

The Importance of Control in Accumulation

I won’t pretend to be anything close to a decent golfer. But even as a layperson feebly swing a club, one of the earliest lessons I learned was one of control. When you’re starting out, the greatest temptation is to swing as hard as you can. But there’s a sweet spot. At some point the harder you swing the worse you get.

It’s not even a matter of just making contact. Strike the ball 100 times, and it will never land in the same spot more than once. The average spot on the fairway may seem decent in isolation, but it’s the number of balls in the bunker, rough, and water that differentiate a good golfer from just another guy with a club. And the harder you swing, the greater the uncertainty.

The equivalent in investing to reaching for the longest driver in the bag for every situation is piling everything in stocks. Yes, the average return of the total stock market portfolio is quite good. But there’s more to it than that.

Like mapping the path of the ball for 50+ consecutive swings of the driver and plotting the spread of outcomes, this Target Accuracy chart shows every real-world growth path of a total stock market portfolio since 1970 starting with $10,000.

The straight gray line represents the theoretical growth assuming you received the simple long-term average every year, and the vertical line samples the full range of outcomes after 10 years. Look at the numbers at the bottom. Imagine having $21,677 after 10 years as the flag you’re aiming for and swinging away.

The chances of nailing a hole in one are vanishingly small, and there’s a wide range of hook and fade on both sides when you swing that hard. Investors usually don’t get too upset about missing to the upside, but check out the minimum outcome. Imagine this is not just a simple recreational game, but a college fund or retirement account that only reached 30% of your goal on your needed timeframe. How would you feel?

As an alternative, let’s look at the same chart for the Golden Ratio Portfolio.

See the difference?

The average real return of the Total Stock Market portfolio since 1970 was 8.0%, while for the Golden Ratio portfolio it was 6.6%. While it may sound like a no-brainer that swinging harder is a better choice for a 10-year accumulation goal, check out the minimum here. The worst case for the Golden Ratio portfolio was double that of the stock market. By easing up just a little, this investor greatly reduced the uncertainty and improved their odds of landing closer to their goal. That’s what I mean by minimizing your miss.

To be fair, though, the two portfolios do have different risk profiles and the average outcomes are not the same. In fact, Frank Vasquez is very clear that he sees the Golden Ratio as a decumulation portfolio and encourages his listeners to invest in more stocks during accumulation. I guess this is one of the rare points where I may disagree with Frank just a little. It’s not that he’s wrong. It’s just that I have a different mindset when it comes to accumulation.

When lining up a shot on the course, it’s tempting to swing as hard as you can handle. So for the same amount of investments, you may want to take more risk with the asset allocation. But there’s another variable to consider. Why not simply put a little lift under the ball and aim higher?

Below is a chart that overlays the Total Stock Market portfolio starting at $10k with a Golden Ratio portfolio investor who tightened his belt just a little and found an extra 14% to invest. Drag the slider to see the difference. Pay close attention to the average, baseline, and worst 10-year outcomes at the bottom.

The displayed Golden Ratio starting value rounds to $11k, but I set it to $11.4k to aim for the same 10-year average flag.

Both investors had the same average outcome. But the one who focused his optimization energy on saving and investing a little more had conservative low-end outcomes significantly higher than the person who focused primarily on boosting stocks for the higher returns. Swing under control with an appropriate iron to get some lift under the ball instead of just swinging harder with the same savings, and your odds of staying on the fairway go way up.

So from my perspective, I think describing the Golden Ratio Portfolio as solely a retirement portfolio sells it short. If you have a financial goal you’re aiming for in accumulation, risk parity portfolios can be great tools to help minimize your miss and ensure a positive outcome. While investing heavily in stocks may work great on average but fall well short for many, practicing a mindset that focuses equally on maximizing savings and minimizing uncertainty can make you a seriously good financial planner with less chance of disappointment.

The Benefits of Consistency in Retirement

I do understand where Frank is coming from, though. There is no doubt that the concept of portfolio dependability is even more important once you switch from accumulation to decumulation. In fact, even if you don’t realize it, the entire concept of safe withdrawal rates is built around the idea of minimizing your miss.

Returning to our portfolio examples, here is a Withdrawal Rates chart for the Total Stock Market portfolio.

Every blue line in this image represents a different retirement cohort since 1970. So one retired in 1970, another in 1980, and so on. Think of it as similar to the full spread of outcomes we just studied in the Target Accuracy chart. The vertical axis is the withdrawal rate that depleted the portfolio to exactly zero, and horizontal axis is the length of the retirement. The intersection of the vertical line and worst-case curve represents the standard 30-year safe withdrawal rate referenced in most retirement literature.

The first thing to note is the sheer spread of outcomes. In the best historical case, a retiree could have spent an off-the-chart amount of more than 10% of their initial portfolio, increased that by inflation every year, and lived like a king for 30 years! But in the worst case, that number dropped to only 3.8%. The conservative number that ignores the rest of the lines and plans around the worst case is what is known as the safe withdrawal rate. And it’s called safe for a reason. While there are no guarantees in investing, it’s the number you want to plan for to protect yourself from unintentionally shanking your retirement into the water.

The 3.8% you see here is a little lower than the famous 4% rule that is most cited on this topic. The reason is that stocks are risky and uncertain. The original studies recognized that fact and sought to boost the safe withdrawal rate by adding bonds to the portfolio to smooth the ride and improve the results. Here’s what the same chart looks like for the Classic 60-40 portfolio of large cap blend stocks and intermediate term treasuries.

The 30-year SWR for the Classic 60-40 portfolio was 4.1%, which aligns nicely with the standard 4% rule we have all heard of. Interestingly, the average real return of the Classic 60-40 was just 5.8% compared to 8% for the Total US Stock Market. So how did the withdrawal rate go up and not down?

I could get into long explanations of How Safe Withdrawal Rates Work or dive into the math of Shannon’s Demon, but today let’s keep it simple and look at the mass of blue lines. Move the slider back and forth and focus on the difference in the spread of outcomes between the two portfolios.

The Classic 60-40 may have had a lower average return, but its spread of withdrawal rates was just a little bit tighter. And since safe withdrawal rates focus on the low extreme to keep you on the green and out of the sand in retirement, the extra consistency makes a nice difference.

The thing is, there’s absolutely no reason to stop at just US stocks and intermediate US bonds. There are so many more asset options available to investors today, and also new allocation philosophies like risk parity that are more economically sophisticated than simply dialing back stock risk a few ticks on the dial. Apply the exact same analysis to the Golden Ratio portfolio, and the results look like this.

Even before looking at the numbers, the overall difference is immediately apparent. The Golden Ratio portfolio was just way more consistent, with a remarkably tight collection of withdrawal rates no matter what timeframe you study.

By building an asset allocation that focuses not just on the average outcome but also on consistent outcomes in all economic environments, one can drastically improve their retirement experience when they happen to retire at an unlucky time. Like other portfolios with intelligent diversification, the Golden Ratio portfolio succeeds in retirement not because it is lucky but because it is measured. Smart retirement planning largely revolves around avoiding the worst outcomes.

Or put another way, maximizing withdrawal rates is all about minimizing your miss.

The Joy of Smartly Playing the Game

While the lesson of minimizing your miss is a valuable one in both accumulation and retirement, I do think it’s important to draw a distinction between risk management and fear. I understand how some people might interpret this theme as a recommendation to be overly conservative, but that’s really not what I mean at all.

There seems to be a trend today for financial personalities to talk a big game about finance but peddle in so much fear that they really have no interest in taking serious action with their own money. On the accumulation side, the idea of cutting every cup of coffee out of the budget became so prevalent in personal finance that it eventually became a derisive stereotype. And in retirement, it’s interesting how many of the most knowledgable people on the topic continue to seek additional reasons to reduce withdrawal rates to the point where you might as well never retire at all.

In both cases, they’re basically just afraid to spend money. And if you don’t spend money, all of that energy you’re putting into financial education doesn’t actually get you anywhere. That’s not the same as minimizing your miss. It’s more like taking your ball and going home.

For me, the point of thinking so much about uncertainty in investing is not to feed fear or to discourage people from playing. To the contrary! I see it as becoming a smarter investor who knows how to judge a shot, choose a club, and reach a goal on my own investing timeframe.

It’s also important to note that the biggest difference between investing and golf is that there are no mulligans. You don’t get 50 chances for every shot, and veering off course has serious consequences. That doesn’t mean that you shouldn’t invest! It just means that you should take a moment to thoughtfully consider your next shot before swinging away with the same old driver. And part of that consideration should be whether you’re focusing too much on average returns and not enough on things like a dependable asset allocation and a healthy savings rate.

When presented with a long-term goal, is your first instinct to dial up leverage and keep swinging for the fences until one ball hopefully lands somewhere near the hole? Do you study the course forever, eyeing every blade of grass and noting minute changes in headwinds, while refusing to play? Or do you take a controlled swing with a solid portfolio and make par with ease?

You’re up. You only get one swing from here, and you have to work with wherever the ball lands. The hole is a financial goal you have always wanted to reach. How will you play it?