Stop worrying about your portfolio

Investors have a tendency to obsess about their investment portfolios. On the
surface, this is a perfectly reasonable focus given results in the portfolio are a crucial determinant of success for whatever purpose the portfolio is there to serve. But performance of one’s investment portfolio is not the only determinant of success,
and it is almost certain that investors would achieve better overall outcomes if
they recognized the risks outside of their portfolios that really matter and invested accordingly. Such a shift in mindset, while theoretically almost unarguable, does run into a couple of practical hurdles. The first is that the investment portfolio is the piece of the problem that is easiest to measure, and investment professionals are generally judged on measured outcomes. While a particular portfolio might be the right one for the specific assets and liabilities of a given investor, if that portfolio underperforms those of the investor’s peers, it is not clear whether an investment committee will care much about the theoretical superiority. The second issue is that once we move beyond the investment portfolio, estimates of risk and correlation are necessarily judgment calls and investors or risk managers cannot simply rely on a historical returns-based covariance matrix to estimate overall risk. That said, just because solving a particular problem is hard doesn’t mean the right thing to do is come up with an easier problem to solve that is less relevant. I’m going to make the argument as to why traditional ways of thinking about portfolios are flawed and can lead investors to make bad decisions.