Imagine this: you’re in a car leaving town for a lengthy road trip. You reach the highway and push down on your gas pedal to accelerate. You can feel the car picking up speed, but something’s missing. There’s an eerie silence as the car begins to move faster and faster.
Concurrent with a step onto the gas pedal, we naturally expect to hear the car’s engine roaring. The satisfying sound of a revving engine is as innate to the driving experience as the sound of crashing waves are to the beach.
But today’s car engines have become so efficient that they simply don’t need to give off the same rumbles and roars as they used to. However, as described above, hitting the gas pedal and accelerating in silence feels like something’s missing.
Automakers have recognized this paradox, and found a solution: fake engine noise. Most of the engine noise we hear today is just for show. It’s often played through the car’s speaker system or is otherwise enhanced to placate our aural desires.
This fake engine noise is an example of a skeuomorph. A skeuomorph occurs when something new unnecessarily retains elements of its predecessors for aesthetic purposes only. Like the shutter-click sound heard when taking a picture with an iPhone or the act of swiping to turn the page on a Kindle, skeuomorphs are totally unnecessary, but feel natural.
At our firm, we frequently come across portfolios that are skeuomorphs.
Over the course of time, it’s not atypical to see a portfolio collect dozens of investments – a little bit of this stock, some of that mutual fund, maybe a dash of this ETF.
The skeuomorph portfolio contains tones and shades of every fad or idea that’s existed over the last few decades – some sensible and others not. It might contain pieces of an old advisor’s asset allocation, some hot ETF from 2011, and a few shares of a favorite company. All holdovers from past iterations of an investment plan that is likely now obsolete.
The danger of the skeuomorph portfolio is that it can easily masquerade as being “diversified”. However, this diversification is as real as the engine sounds coming from a 2018 Ford F-150.
The sheer number of holdings a portfolio has tells us nothing about its risk-return profile. We’ve seen portfolios with 50 holdings that are less diversified than others with 5. Ironically, in the act of owning a little bit of everything, the skeuomorph portfolio ends up owning nothing. Once analyzed comprehensively, we usually find that these portfolios simply amount to a large, inefficient index fund replete with overlapping, unnecessary holdings.
Making investment decisions absent the context of a comprehensive financial plan is an easy way to end up with a skeuomorph portfolio. The path of least resistance is to retain portfolio holdovers and add new slices of things that seem sensible. What begins as harmless can turn into a slippery slope. Absent the frame of reference that a financial plan provides, literally anything at any time might seem like it makes sense.
Creating a comprehensive financial plan can provide the context needed to decide whether something has a place in a portfolio or not. It can also help identify how to simplify a skeuomorph portfolio into something more efficient, understandable, and manageable. As Leonardo da Vinci once said, “Simplicity is the ultimate sophistication”. Eliminating unnecessary portfolio elements can be a liberating experience.