How to Build a Smarter Investment Portfolio (A plan you’ll actually stick to!)
Designing an investment portfolio isn’t only about finding the “good” returns. It’s about balancing risk, behavior, and real-world goals in a way that works for you.
In this article, we’ll unpack how to approach portfolio design the right way – with a focus on asset allocation, risk management, and the behavioral traps that sabotage returns more than anything else.
The Myth of the “Perfect” Portfolio
You may hear about software that claims to generate the “optimal” portfolio for you. These programs use historical data and mathematical models based on Modern Portfolio Theory, developed by Harry Markowitz in the 1950s.
Markowitz’s insight was powerful: combining investments with different risk profiles and correlations can reduce overall volatility without sacrificing returns.
But in practice, “optimal” portfolios aren’t knowable in advance. They rely on assumptions that change constantly – future returns, correlations, risk preferences – and they’re highly sensitive to the inputs you use.
It’s like trying to predict the perfect meal based on what ingredients will taste best 20 years from now.
The takeaway? “Perfect” is the enemy of “good.” Aim for a return high enough to meet realistic goals, and stick with it.
That’s ultimately what matters – the ability to spend time with family, take that extra vacation, buy the car you wanted, etc.
There is no point in taking excessive risk if you can achieve these in a safer manner.
- An important note, a “good” rate of return – one that is close to what the market returns – is actually much higher than what the average investor achieves due to their own behavioural issues like selling out at the bottom and rebuying in when it recovers. You do not need to beat the market to have a good return and meet your goals.
What Is Asset Allocation
Asset allocation is the process of deciding how much of your portfolio to hold in different types of investments – typically things like equity funds, bond funds/GICs, real estate, and cash.
We aren’t talking about picking individual companies. It’s about deciding how much risk to take on, and what mix of assets gives you the best chance of reaching your goals, based on your situation.
In fact, your asset mix explains most of your investment performance over time – not which fund manager you choose or what investment you heard about last week.
Your Portfolio Is More Than Just Investments
When building a portfolio, it’s important to consider all your assets — not just your investment accounts. This includes:
- Human capital: your ability to earn an income in the future
- Pensions or stable income streams
- Business ownership or private investments
- Home equity and real estate
- Social capital: support from family, community, or government programs
These factors influence how much risk you need to take – and how much you can take without panicking during a downturn.
For example, if you have a defined benefit pension (like from a hospital or government job), that’s similar to owning a large, stable bond. It might allow you to invest more aggressively in your portfolio without taking on too much overall risk.
Does Age Matter?
You’ve probably heard rules of thumb like “100 minus your age = how much you should have in equities.” But reality is more nuanced. One interesting insight comes from economist Francisco Gomes, whose research suggests that as your wealth grows, your tolerance for risk often grows too
For many high-income professionals, a flat asset allocation throughout life (rather than gradually shifting to more bonds) may be more appropriate. There are other academics that suggest that bonds are actually risky over the long-term due to inflation and their lower expected returns, who suggest even higher equity allocations! While I don’t recommend this in general, for the right person it may make sense.
Ultimately it’s still personal. Your goals, personality, and past experience with market downturns all play a role.
If you’ve lived through a crash, stayed invested, and felt okay – that is incredibly useful information in regards to your real-world risk tolerance.
What Does “Risk” Really Mean?
In investing, we often equate risk with volatility – how much prices go up and down. But there are many other forms of risk to consider:
- Market risk: the broad ups and downs of the economy
- Inflation risk: the loss of purchasing power over time
- Shortfall risk: not having enough to meet your goals
- Covariance risk: how your investments behave in bad economic times
- Behavioral risk: sabotaging your own plan
The biggest risk of all? Not sticking with your strategy when times get tough.
Why Some Investments Seem to “Win” Over Time
In historical data going back to 1926 (via the Center for Research in Security Prices or CRSP), we see a clear relationship:
- Equities beat fixed-income
- Riskier funds (like small-cap or value funds) beat safer ones
- Compounding over time makes a huge difference
For example, $1 invested in U.S. Treasury bills in 1926 grew to just $21 by 2022. But that same $1 in U.S. small-cap value funds would have grown to over $140,000.
These are staggering numbers, but they come with an important caveat: riskier assets are harder to own. They’re more volatile, more stressful, and more prone to big drawdowns. You don’t get higher expected returns for nothing – you get paid because they’re uncomfortable.
And even over long periods, riskier stocks can underperform. Owning them takes conviction and the right temperament.
The Behavioral Gap: Why Most Investors Earn Less Than Their Investments
Even a great portfolio won’t help if you can’t stick with it.
Research by Morningstar in their Mind the Gap report shows that investors, on average, earn 1.7% less per year than the investments they hold – simply because they buy high and sell low.
This “behavior gap” is even worse for hot, trendy funds and sector-specific investments. For example, in the case of the hot tech-focused fund by Cathy Wood in the 2010s and beyond (which soared and then crashed), Morningstar found that the average investor earned 35% less per year than the fund itself over time.
Why? Because investors piled in after the big gains – and bailed out during the crash. They couldn’t handle it.
In contrast, broad, low-cost asset allocation funds had a much smaller behavior gap — closer to 0.7% per year — thanks to their diversification, automation, and lack of hype.
What Makes a Portfolio Actually Work
Based on all the data and behavioral research, here’s what tends to work best for real people:
- Diversification: across asset classes and globally
- Low costs: high fees eat away returns, especially over time
- Automation: reduces the temptation to tinker
- Avoiding complexity and hype
- Aligning your strategy with your actual risk tolerance
The right portfolio isn’t the one with the highest return on paper. It’s the one you can actually stick with through good markets and bad — so that your behavior doesn’t sabotage your results.
Final Thought
Good portfolio design is part science, part self-awareness.
Yes, there are principles grounded in solid research – like risk premiums, diversification, and the relationship between expected return and volatility. But at the end of the day, your portfolio should serve your goals, not just your spreadsheet.
The best portfolio is one that’s evidence-based, behaviorally sound, and built for you – not for your neighbor, your coworkers, or the latest headline. Give me a call if you feel like yours needs work.
Disclosures:
Important information about mutual funds is found in the Fund Facts document. Please read this carefully before investing. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Unit values and investment returns will fluctuate.
The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.
