Perception versus Reality: Managing Risk

While we spend time analyzing each of our individual positions and holdings, when it comes to portfolio management, the whole is very much more than simply the sum of its parts (Harry Markowitz won a Nobel Prize in 1990 for this insight). By definition, a well-diversified portfolio of assets (i.e., a portfolio of investments that do not all move together in the same direction) will contain some laggards during any given measurement period, particularly over shorter-term periods. But it’s at least as important to focus on the overall portfolio and how the pieces fit together and complement one another—how they are performing relative to each other and whether that performance is consistent with the original rationale for owning them.

Successfully managing portfolios also requires the discipline to resist trading based on emotion (fear and greed), rather than on long-term return drivers such as valuations, yield, and earnings growth. Even in an advanced economy like the United States, the stock market has had at least a 10% decline every 16 months on average since 1950. Bear markets (20% or greater declines) in the United States have happened about every seven years, on average. The catch is that in most cases you can’t predict what the exact cause of the volatility will be or exactly when it will hit. Even if you did successfully call the bear market, you’d need to also successfully time your re-entry so as not to miss out on the subsequent gains. And you’d need to do this consistently and repeatedly over an investment lifetime. That is simply not realistic, which is why our tactical investment approach is based on a range of potential outcomes and a longer-term time frame. As the examples we discuss below illustrate, in our view, making investment decisions based on short-term market forecasts (guesses) is a losing game. We have no confidence that this approach can be executed successfully over time.


In the run-up to the vote, polls suggested the outcome could be close but would most likely result in the United Kingdom remaining in the European Union. Financial markets were clearly surprised by the opposite result. Global stocks sold off in the two days following the vote. The Vanguard 500 dropped 5.3%, emerging-market stocks fell 6.7%, and European stocks plunged 13.6%. In contrast, the core bond index gained more than 1%.