Any tennis player, golfer or baseball player can affirm that there is an area on the face of a racket, club or bat that is referred to as the sweet spot. It varies in size, but it is the optimal location on the particular instrument that the athlete wants to hit the ball. Anyone who can hit their sweet spot consistently will tell you that it makes all the difference in their expected results. Not only do they increase the odds of their preferred outcome but the effort required to place the ball where they wanted is reduced. In fact, a perfectly hit sweet spot can almost feel like they are hitting nothing at all. Whereas a missed sweet spot, not only fails to hit the target, can actually cause physical pain in certain instances.
What does this have to do with investing? A lot. Investors all want the same thing, that being the highest possible return with the least possible risk. The problem is that goal is unrealistic, too arbitrary, and performance based. Since risk and return expectations differ from person to person, and can change with the wind, we need something more concrete. Enter the optimal portfolio. That is the asset allocation (the blend of stocks, bonds and cash) which will offer you the highest possible return given a stated risk tolerance or the lowest possible risk given a stated return objective. Select your risk or your return objective but one has to fluctuate.
An optimally structured portfolio is like the sweet spot on a tennis racket and should produce the greatest results with the least amount of effort. It should be a function of the owner’s goals and objectives and its structure will change over time as those goals and objectives change. Since each investor’s situation is unique, their optimal portfolio will be unique to them. Just because your neighbor or golfing buddy owns a particular investment doesn’t mean that would be the best fit for you.
Another way to look at it is the optimal portfolio will offer you the highest reasonable probability of reaching your goals with the lowest reasonable downside risk. Now we are no longer talking about performance, but instead goal-attainment as the measure of success. This is a much more productive and measureable process since returns will always wax and wane but your probability of attaining your goals should remain consistent. Only through a comprehensive analysis of your goals and objectives and the resources available to fund those goals can you learn what portfolio will likely offer you the greatest probability of success. The optimal portfolio is your personal sweet spot. Do you know what your optimal portfolio is? If not, why not?
Although hitting the sweet spot on a tennis racket may be simple, it’s certainly not easy. So too, when it comes to investing. Being a successful investor is actually pretty simple, but nothing about it is easy.