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Investing Specialists

There's More to Investing Than Just Risk and Return

In praise of what can't be measured.

Morningstar.com's annual Portfolio Makeover Week showcases real-life strategies for navigating the most common investing questions. Our 2021 makeovers will feature the before and after portfolios of five investors at various life stages and asset levels. Complete this form by Oct. 8 for your chance to have your questions answered and your portfolio profiled by Christine Benz.

I recently wrote an article about my "too hard" pile--Charlie Munger's term for investments that are too complicated to make it into Berkshire Hathaway's portfolio of companies. Some people collect more investments and build more-complicated portfolios as they pick up experience and assets. I'm trying to take Munger's lead and go in the opposite direction. The more I know, the more I can't be bothered with the arcane, the volatile, the hard to understand. Instead, I crave simplicity, peace of mind, and the ability to be asleep at the switch and know that things will be OK. I also put a big premium on my time. If an investment requires frequent monitoring, I'm out.

I'm not alone in this mindset; I heard from several readers after the column published that they, too, have "too hard" piles. Given that, it made me wonder why risk and return dominate the discussion of investments' worthiness? Why aren't we also judging investments, portfolios, and financial choices based on whether they impart peace of mind and are simple, livable, and low maintenance?

The Tyranny of What Can Be Quantified …

I have a guess: It's because attributes like simplicity and peace of mind can't be quantified and are subjective, whereas the other stuff can be weighed and measured. Investment researchers have created scores of metrics to help depict how well an investment has balanced risk and return: the Sharpe ratio, the Treynor ratio, the Sortino ratio, and the Morningstar Rating, to name just a few. We also talk about how investments fit on the efficient frontier--how well they've compensated investors for the volatility they've assumed.

Meanwhile, attributes like whether an investment imparts peace of mind or requires minimal oversight can't be quantified because they're inherently subjective. You might derive peace of mind from knowing that your portfolio is positioned for long-term growth, whereas another investor's definition of peace of mind is more conventional. You might be OK with spending five hours a week researching investments; another investor might say that five hours a year is more time than he cares to give.

… and What Can't Be

Nonetheless, creating the right portfolio for you should involve some self-reflection on these softer issues, because optimizing your investment choices isn't just about risk and return. It's about creating a portfolio that can get you to your goals without interfering with the rest of your life. It's also likely that your views on these issues have evolved over time, so you may need to course-correct to ensure that your portfolio reflects your current thinking. The individual-stock-heavy portfolio that engaged you when you were younger may seem too complicated and labor-intensive--not to mention too risky--as retirement approaches.

Here's a short list of nonquantifiable, decidedly subjective issues that should factor into the appropriateness of your investments and your overall plan.

Peace of mind: Some might argue that an investment's volatility is a good proxy for whether it imparts peace of mind, but I don't think that's the case for everyone. For me, peace of mind comes from knowing that my plan is on track, even though that entails having money in volatile assets. If my portfolio experiences periodic swings, I view that as the price I pay for the chance to earn strong long-term returns. Others might have a more conventional definition of peace of mind; volatility in their investment portfolios keeps them up at night. The key is to think through your own definition of peace of mind and make sure that your portfolio is striking the right balance.

Enough: Investment guru Bill Bernstein has advised "if you've won the game stop playing." Jack Bogle wrote a whole book about this topic. Nonetheless, I don't think we talk enough about how to identify our own versions of "winning" and "enough" when we're thinking about our own portfolios and our plans. One of the most illuminating portfolio makeovers I've worked on was with a retiree who was living on a very modest amount but was content to stand pat with a very conservative portfolio. My gut response was to increase the risk in his portfolio to improve its return potential. Didn't he want to spend more or leave a bigger nest egg for his daughter, I asked? No and no, he answered; he was very content with his lifestyle and knew his daughter would be just fine, too. I wish we were all operating with so much self-awareness of "enough"--how big our portfolios need to be, how much we need to save and spend to have good lives, and how much risk we need to take in our portfolios to ensure a high quality of life. "Enough" is a relative of peace of mind, but it's arguably an even more fundamental consideration because it relates directly to lifestyle choices.

Simplicity/Ease of Use: Here's a factor that has greatly influenced my growing "too hard" pile: How straightforward are my investments and how much of my time does managing them and my total portfolio demand? To what extent is an investment goof-proof in case, for whatever reason, I'm not able to pay attention to it for a good long while? I know that Morningstar.com attracts a lot of investment hobbyists, and if that describes you, this consideration probably doesn't resonate with you at all. But the older I get, the more I realize that the only true finite resource in this world is time, and I don't wish to spend a lot of mine managing my portfolio and my underlying investments. If you're in that same camp, you could consider embracing a truly minimalist index-fund portfolio, buying a simple target-date fund, or delegating oversight of your portfolio to a financial advisor. At a minimum, think through your succession plan for your portfolio in case you're unable to manage it on your own for a period of time.