Optimizing Returns from Highly Diversified Investment Portfolios: Insights from Warren Buffet
When it comes to measuring the success of a highly diversified investment portfolio, one key metric often turned to is the historical average return on the SP 500. This renowned index provides a valuable benchmark for understanding the performance of a well-diversified portfolio.
Understanding the SP 500: A Benchmark for Success
The SP 500 has a historic average return of approximately 10% since its inception in 1928. This figure is particularly interesting because it serves as a baseline for investment performance. However, it's important to note that a highly diversified portfolio, which typically includes a mix of stocks and bonds, is unlikely to match this exact figure. On average, the inclusion of bonds in such a portfolio will result in a lower return, often falling below the 10% mark.
Comparing Diversified Portfolios to the SP 500
Over a decade, numerous studies and empirical evidence consistently show that diversified portfolios, while offering diversification benefits, rarely outperform the SP 500. This observation aligns with the advice of Warren Buffett, one of the most successful investors of all time. Buffett's recommendation is to invest solely in the SP 500 index, a strategy he conforms to himself. His rationale is rooted in the simplicity and cost-effectiveness of this approach, as well as the difficulty in consistently outperforming the market.
Why Professional Managers Struggle to Beat the Market
Professional mutual fund managers, despite their expertise and resources, do not consistently beat the market. Studies indicate that only around 20% of mutual funds outperform the SP 500 in a given year, and this number varies significantly each year. This volatility in performance makes it challenging to rely on professional managers to consistently deliver superior returns.
The Set and Forget Investment Strategy
Given the difficulties in consistently outperforming the market and the costs associated with maintaining a diversified portfolio, many investors are seeking simpler and more cost-effective approaches. Warren Buffett's advice to invest in the SP 500 with a "set and forget" strategy is gaining traction among investors. This strategy not only simplifies the investment process but also minimizes transaction costs and management fees, leading to potentially better overall returns.
Strategies for Targeting Premium Returns
For those looking to target returns above the market, such as outperforming the Dow by 2%, the key is to set clear return targets relative to the risk you are willing to bear. Historically, the stock market has traded at a 11-15 P/E ratio, translating to a potential 6-9% return. Consistently beating this range is a challenging goal, one that most investors find difficult to achieve on a sustained basis.
Conclusion
In conclusion, the pursuit of highly diversified investment portfolio returns often leads to challenging goals and complex choices. While a diversified portfolio can offer diversification benefits, it is important to consider the limitations and the historical performance benchmarks, such as the SP 500. Following Warren Buffett's advice, focusing on a simple, cost-effective strategy may offer the best path to consistent and sustainable returns.