Free Wealth Management Guide Building An Effectively Diversified Investment Por | Page 4

Active Management Fails Over the Long Term
As you increase the length of time you invest, outperforming the market becomes even more difficult. In a 2008 research study (2) – perhaps the most comprehensive study
ever performed – a team of professors used advanced
statistical analysis to evaluate the performance of active
mutual funds. They looked at fund performance over a
32- year period, from 1975 – 2006. The study concluded
that after expenses, only 0.6% (1 in 160) of active mutual funds actually outperformed the market through
money manager’s skill.
If you manage money yourself using active management
strategies or invest in funds that use this type of approach,
the results of this study indicate you will likely end up
with less money for retirement than if you had used a
passive index benchmark.

The Strategy in a Nutshell
Although the strategy used in building the portfolio discussed in this Wealth Guide is highly sophisticated, I will
try to explain it in two sentences. In a nutshell, this portfolio uses 13 no-load, low-cost asset class mutual funds
to create a portfolio that owns over 12,000 securities in
44 or more different countries. The portfolio represents
multiple asset classes and uses strategic asset allocation to
overweight security holdings to small and value companies which, over time, have significantly out-performed
small and growth companies.
You can come close to creating this strategy using index
mutual funds or exchange traded funds. You will not,
however, be able to exactly replicate this portfolio using
those funds. As I will explain later, there is a difference
between index funds and the asset class funds that comprise this portfolio.

A Structured, Long-Term Buy & Hold Approach
This portfolio is not for everyone. If you are someone who
believes that you can consistently outperform the market
using active management tactics, such as stock picking,

sector rotation and market timing, this is not for you. If
you are the type of investor that likes to “test the waters”
and dabble with a strategy for short periods of time,
don’t even bother using this approach. This short-term
thinking is what often causes investors to earn inferior
long-term investment performance.
The portfolio is not based upon speculation. It is not
based on anyone’s ability to predict what is going to happen in the future. It does not attempt to identify which
stocks, sectors or asset classes will be “hot” in the near future. If that is what you are looking for, you won’t find it
here. This strategy uses a structured buy & hold approach
to produce long-term results which requires patience and
discipline.
I am often asked how this portfolio performed over the
last year or so. This let’s me know the person asking this
question doesn’t understand the strategy. People typically
ask this question because they want to compare the performance of this portfolio to their current portfolio or to
an investment they recently heard or read about. Jumping
from one strategy to another is a large reason most investors underperform the market over time.

Starting Benchmark
Through a series of five steps, I will illustrate how we
build an effectively diversified investment portfolio.
Starting with a benchmark portfolio titled “Portfolio
One”, we will add asset classes with an attempt to increase
returns while maintaining a low standard deviation. You
will see the end results of these steps in “Portfolio Six.”
With each successive portfolio, we will look at:
• The annualized return from January 1970 through
December 2012.
• The annualized standard deviation from 1970
through December 2012.
• The growth of $100,000 from January 1, 1970
through December 2012.
To measure the success of our portfolio, we will use a
starting benchmark portfolio comprised of 60% Standard
& Poor’s (S&P) 500 stock Index and 40% Barclay’s Gov-

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