I read a lot of books about investing, economics, the nature of money, ethics … When I read something that I find particularly impressive or interesting, I’ll write something up and post it here.   Timothy F. McCarthy. The Safe Investor: How to Make Your Money Grow in a Volatile Global Economy. Palgrave: 2014. (Kindle editionbook site)   I was asked to read this book by a client whose dad had read it, and was recommending it to her pretty emphatically. “You gotta ask your advisor what he thinks!”, he said. I picked it up on my Kindle, and was able to read it pretty quickly. McCarthy brings some pretty impressive credentials to a book about investing — he’s been in senior management roles at several important financial services firms, including Charles Schwab and Fidelity , as well as several important firms in East Asia. His experience in both the US market and international markets makes me confident giving his words significant weight. McCarthy points out that most investors are more worried about risk than they are willing to admit — or, more accurately, that most of us are more loss-averse than we think. We are more likely to give up on good opportunities if we think that they bear a significant risk of losses. But he believes that working with a well-qualified advisor, who knows how to build long-term, properly-diversified, low-cost portfolios, is our best bet for investment success. He recommends (in chapter 6) finding a “registered investment advisor” (RIA) who is paid by your fees and takes fiduciary obligations seriously. And he thinks that SRI investments might well be worthwhile — as long as you do the research you need to, in order to be sure that they’re good investments and represent your values (ch 14). The core of this book, I think, is aimed at those advisors: McCarthy believes that the time has come to make a significant change to our default diversification schemes. If we take a long time-horizon, and look at global demographic trends and economic patterns, we can see that the “developed world” is currently stable but dragged down by a rapidly aging population. Economic growth for the forseeable future is likely to be limited, McCarthy argues. In contrast, the “developing” or “emerging world” is moving rapidly to catch up with more mature economies, buoyed by young populations and huge economic growth opportunities (chs 9-13). So, in order to take advantage of these opportunities, he recommends putting nearly half of a portfolio’s holdings into stocks and bonds from emerging markets (ch 14). Now, we certainly agree that some allocation to emerging markets is important. But while McCarthy’s heavy allocation is supposed to create a “safe” portfolio, we believe that it would expose us to far more portfolio variability and volatility than we think is prudent.
Balanced Portfolio: 50% Stock, 50% BondProjected ReturnProjected VolatilityAmazing Year ReturnDisastrous Year Return
“Safe” Portfolio5.96%12.17%+30.30%-30.55%
HSFS “Balanced I”5.75%8.79%+23.31%-20.62%
These two portfolios are expected to perform very similarly over the next decade or two, on average. But their performance along the way will almost certainly not be similar. In a glorious year, when everything in the portfolio is trending upward, the “safe” portfolio will probably outperform significantly. But it can be expected to give all of that and more back in a disastrous year. What if those emerging markets securities take a huge beating, just when we need to make a substantial withdrawal? So, while we like some of McCarthy’s recommendations — yes, hire a fee-only fiduciary advisor, diversify your portfolio, do the due diligence research, stick to your discipline, consider your values as part of your portfolio construction process. But we think that his specific recommendation to make a heavy bet on emerging market countries and securities is less than wise — and not the way to build a “safe” portfolio.