13 min read

Swensen’s Key to Investing Performance

Last week, while taking a look at how we can better measure our success as investors, I mentioned that legendary endowment fund manager, David Swensen, attributed 90% of a portfolios performance to diversified asset allocation. Today I wanted to take a closer look into what that means, and what other factors he attributes the remaining 10% to.

David Swensen ran Yale University's endowment fund for more than 35 years, during which time the fund saw incredible success, easily outperforming similar funds. Naturally, people were curious about what the thought were the main drivers to long term success, and his answer may surprise you.

Instead of saying his success came down to picking the right stocks, timing the market, or some complex algorithm, he said that diversified asset allocation plays the biggest influence on long term returns. Asset allocation refers to our portfolios recipe, the mixture of primarily stocks and bonds. He said that asset allocation can account for up to 90% of a portfolios long term performance, with security selection, and market timing combining for the remaining 10%.

It's a fascinating revelation, especially considering how much emphasis the entire globe can place on a single stock at times (I'm thinking of you, meme stocks). It's an idea, that suggests people put too much emphasis on things that don't matter, while ignoring the things that do. Like most things in life, differentiating between the things that matter and the things that don't, feel like half the battle. But it allows us to better understand where we should focus our time.

Key Takeaways:

  • Diversified asset allocation refers to the recipe of our portfolio: its ingredients and the measurements of each.
  • Timing and selection provide little financial value for someone who perfects it, compared to someone who doesn't prioritize it at all.
  • Diversified asset allocation provides our portfolios with safety, longevity, and exposure to the investments we need to get the results we hope for.

Asset Allocation

The construction of our investment portfolio is very similar to baking cookies. Instead of chocolate chips, our portfolio can be made up of a variety of different ingredients: stocks, bonds, real estate, alternatives, or cash. Asset allocation is like the recipe, it gives us the measurements of each ingredient of our portfolio, measurements that are based on our risk tolerance and financial goals. Maybe it would look something like this:

If you've ever baked cookies, you know that the recipe, is just as important as the ingredients themselves. The wrong measurement of even a single ingredient can cause the cookies to be thrown into the trash. With investing, the same is true. A portfolio with the wrong ingredients or recipe, can cause our investing strategy to be out of alignment with our goals. For example, a portfolio with too much stocks could increase volatility (bad for short term goals), while not enough stocks could reduce growth potential (bad for long term goals).

Recipes are specific, you can't really take ingredients and measurements from one recipe, switch things up, and expect it to be perfect for another. Asset allocation should be based on things that are specific to each of us, based on our goals, and what matters most to us. What works for someone else, isn't guaranteed to be right for us.

For example, is let's imagine two people who have the exact same job, same: title, income, benefits, etc. They might look like they're in the same situation based just on that. But if we look past employment, they're likely to have differences in: expenses, living situation, family, dependents, lifestyle, financial obligations, retirement goals, life expectancy, the list goes on and on. So even two people who appear to be in similar situations, deserve unique evaluations of what would be best for them.

The Power of Diversification

Diversification is the idea of not putting all of your eggs in one basket, or spreading out the risk. The more diversified our portfolio is, the more the risk is spread out. So the less impact any one asset class, industry/sector, country, or company should have on our overall portfolio. It's a simple but important concept with investing because it helps prolong the life of our investments. If we were to visualize it, it would look something like this:

It's important to understand that market risk is a constant, it's the small price that we pay as investors, in the form of volatility. Above market risk, there are specific risks, tied to a concentration. It's easy to differentiate between market risk, and specific risk.

Markets naturally have flow, they move up and down, but over time much more up. Depending on the cycle that the overall market is flowing through, our investments may decrease in value. That doesn't mean we picked bad investments, or that we are doing something wrong, it's just a reality of investing. Market risk follows the general flow of markets, sometimes resulting in down periods over an entire year.

Specific risk (to an industry/sector, country, or company), will be much more volatile than the market. It may follow general trends, but with amplified movements. Or due to negative events, their movement may break away from overall trends (periods of decline when overall markets are positive). If we are betting it all on one (or a handful of companies), our result will be tied much more to their specific returns than the overall market.

Diversifying allows us to spread out the risk from a single or handful of companies, to dozens, hundreds, or thousands. It puts our money in a position where we can survive underperforming or even failing. It takes risk from being defined as the chance I lose all of my money, to the chance I experience a short term decrease in value. Two extremely different things.

Investing success comes down to doing the little things right, for a very long time. Diversifying gives us the best odds of being able to invest for a very long time, so in turn, gives us the best odds of being successful over that period of time.


Over time, asset classes will perform differently than others within our portfolio, causing our asset allocation to deviate from its original design. In the example graphic below, stocks and alternatives outperform, while bonds and cash underperform:

If our asset allocation changes too much from its original design, it can expose us to too much risk. This happens in two ways:

  • If we think of the law of averages, something that outperforms is more likely to come back to reality by underperforming
  • With an increased weighting to something we expect to underperform for a period, we may see increased volatility

Deviation from our original designed allocation happens, there's no way around it. But at a point, a rebalance should be triggered. It's a way to sell out of something that has done really well (lock in gains), and allocate those gains to something that has underperformed (but should begin to pull its weight). Even if we don't see a change in how the asset classes are performing, we return our expected volatility to a range within our comfort level and within our plan.

Diversification + Asset Allocation

Diversification and asset allocation are great things individually. But putting them together takes it to the next level, it's like 1+1=3.

If you are well diversified within an asset class, but the allocation towards that asset class is all wrong, then it's likely not a great investment for you. Having a perfect allocation for you is great, but if your stocks allocation is made up of one company, really not good. It can put you in a position where you're exposed to too much unnecessary risk. Even in a good year, it can still be a bad thing.

To illustrate his point, let's look at an exaggerated example. Let's say in a given year: bonds return 3%, stocks return 7%, and the single best investment has a return 20%. Al invests in a diversified portfolio consisting of 50% bonds and 50% stocks, an asset allocation appropriate for his goals. His annual return ends up being 5% ((3%*0.5)+(7%*0.5)).

Al's best friend, Bob, takes a different approach. He picked the one that returns 20%, but his asset allocation was way off. Only allocating 10% of his funds towards that investment, and the rest towards bonds. His annual return ends up being 4.7% ((20%*0.1)+(3%*0.9)). Even though Bob got lucky and picked the best performing stock, he underperformed Al because his allocation was off.

Diversification helps protect our investments from risk, and allows us to be able to survive down years. Asset allocation allows our portfolio construction to be aligned with our risk tolerance and goals, so that we can have the right outcome we are working towards (grow our funds, preserve our funds, or anywhere in between).

Market Timing

Market timing is trying to find the perfect time to enter or exit an investment. The idea of buying low and selling high. There have been commercials around getting into a stock at the right time. We see it all the time with individual companies that are going to the moon. We can feel the constant anxiety of FOMO.

The issue is that no one really knows what's going to happen. At any given time, a stock might go up, or it might go down. The reality is, you only really know a low or high point after it's already passed. Looking back at it in your rearview mirror.

Does Market Timing Work?

Peter Lynch is one of the most successful investors of the 20th century. He ran a fund from 1977 to 1990, which had an average annual return of 29.2%, more than twice the S&P 500 during the same time. He put together data looking at three fictional investors who each invested $1,000 annually from 1965 to 1995. 

The first had terrible luck, and always invested on the most expensive day of each year. The second had incredible luck, and always invested on the cheapest day of each year. And the third always invested on the first day of each year. 

Over the 30 year period, the first investor averaged an annual return of 10.6%, the second investor averaged an annual return of 11.7%, and the third averaged an annual return of 11.0%. Surprisingly, perfect market timing only added 1.1% over the worst market timing, and only 0.7% over no timing at all.

A recent Charles Schwab study looked at five fictional investors who each had $2,000 a year to invest over a 20 year period from 2003 to 2022. Here's who the investors were and when they invested their $2,000 each year:

  • Peter Perfect – on the best day
  • Ashley Action – on the first day
  • Matthew Monthly – divided equally on the first of each month
  • Rosie Rotten – on the worst day
  • Larry Linger – never, stayed in cash waiting for a better time

Here are the results concluding the 20 year period:


Surprisingly, having perfect market timing didn't provide that much more return than simply investing on the first day of each year. The study looked back at a total of 78 rolling 20 year periods going back to 1926. In 68/78 studies they found the exact same order of results. In the other 10, investing on the first day of the year never came in last. The only real loser in the study, was never investing at all.

Time In Market > Timing Market

Let's look at market timing from one final angle: additional benefit per hour. There are approximately 250 days per year that markets are open, and let's say that before the market opens each day, our perfect market timer spends 30 minutes to evaluate where things are to make a decision if they will invest. Even after they make their investment for the year, they continue to spend 30 minutes gauging markets out of curiosity (in total, spending 125 hours/year).

In the Charles Schwab study, the difference between perfect timing and investing on the first day of the year was $10,538. If someone spends 125 hours a year for 20 years, that equals an hourly wage of $4.22, which is 72% lower than the current minimum wage in Manitoba ($15.30/hour). Even the difference between best and worst is only an hourly rate of $10.30.

Looking at the results, it's easy to say that instead of trying to time the market, it's better to just get our money into the market. There isn't much of a difference between investing on the perfect day each year (which is only guaranteed in hindsight) to investing immediately, or investing regularly. Financially, no real benefit, plus more time to spend it on what matters most.

Security Selection

What's your guess to the percentage of mutual funds that are specifically designed to outperform the S&P 500, but actually underperform it? Here's the answer:

% of Large-Cap Domestic Equity Funds Underperforming the S&P 500 Each Year

Of the 22 years on that chart, only twice has the majority of mutual funds outperformed the S&P. Mutual funds have a couple of things working against them: high fees erode returns, and human error – the fact that we don't know what will happen. Sometimes our strategy works, and sometimes it doesn't. The truth is, picking winning companies is hard. There's a lot of variables outside of our control.

We don't have to think for very long to find examples of things not quite going right with stock picks. We can think recently to GameStop or Tilray. But the list of hyped up stocks doing nothing except dropping once the vast majority of people hear about them are endless. It's been the same story for centuries, even to the very first stock market. Even a 'diversified mix' of hot stocks isn't foolproof.

Slow And Steady Is Winning The Race

2020 and 2021 was riddled with headlines questioning if Warren Buffett and his value investing strategy was a thing of the past. Value investing, very basically is a complex and intensive process that looks for stocks on sale. The pandemic lead more people to pay attention to investing than ever before, and certain stocks saw incredible growth. Buffett's company, Berkshire Hathaway, stock price was lagging in comparison. People claimed that value investing, something that has proven time and time again for decades, just wasn't keeping up.

One approach that was far ahead, that was maybe more popular than anything else, was Cathie Wood's ARKK ETF, a fund made up of technology companies, crypto, and the next wave of investments. The fund saw incredible growth, building the hype and making early investors rich. But then the fund saw incredible loss. Google searches related to the fund coincided with the price peak. Yet another classic example of investors chasing gains and being the most confident in a stock, when it was at its highest point. Here's a comparison of ARKK (blue) and Berkshire (orange) over the past five years:

Performance of ARKK (blue) vs BRK-B (orange) over the past 5 years

BRK-B sits at a gain around 5.5x ARKK, proving that being patient is a strategy that should never go out of style. For investors who bought at ARKK's all time high, the current stock price needs to more than triple, just to break even. But even with this clear example, it'll only be a matter of time before Buffett is once again being cast in doubt.

Don't Get Burned By A Hot Stock

Hot stocks can be very alluring, they are new, shiny, everyone is talking about them, and you can feel like a fool if you don't jump in head first. But more often than not, hot stocks burn people. It takes us from being an investor, to being a gambler. It takes us from being in a place of volatility, to being in a place of real risk of losing our money.

Markets offer returns much higher than most people typically receive, because a lot of people are invested poorly. Sticking to low volatility, low return options, thinking that in order to get great returns you need to expose yourself to uncomfortable risk. But that's not the case. By investing smartly, we can hold all of the winners, knowing that the market goes up, and the market goes down, but it goes up much more often, creating exceptional long term returns.

I just heard this quote on a Peter Lazaroff podcast, and I think it fits in here great:

Happiness is the difference between expectations and reality.

We should expect to become rich over decades, not overnight. That should be every investors expectation, and it should govern how our goals and plans are laid out. If we know and understand that, then we can comfortably block out the temptation of hot stocks in favour of our tried and tested plan. Worst case of sticking to a method that works: you end up rich. Worst case of chasing hot stocks: you end up broke.

Diversified Asset Allocation, A Secret No More

Diversified asset allocation does a few things really well for us:

  • It spreads out risk across many different asset classes, industries/sectors, countries, and companies.
  • By spreading out risk, it gives our money safety, ensuring that we can withstand down years to be invested for as long as possible.
  • By investing in many different things, it increases our chances of holding the winners, giving us opportunity for great returns.

There's often a lot of emphasis put on picking the right stocks, and picking the right timing for your investments. But in reality, timing and selection is very difficult, even for professions. More often than not, it offers very little financial benefit over someone that doesn't prioritize timing or selection at all. As we saw, the benefit turns out to be an hourly benefit a small fraction of minimum wage.

We can save ourself a lot of time, energy, and headache, by focusing on what we can control that will give us the most benefit possible, while ignoring the things that don't. At the end of the day, investing is a way to work towards what we want the most, it shouldn't be something that takes us away from what we enjoy doing the most. By prioritizing the right things, we can get the results we dream of, while spending less time to make it happen.

Keep doing things your future self will thank you for.