We think that most investors focus on the wrong thing when evaluating their portfolios? A well-known study by Brinson, Hood, and Beebower (1986) found that over 80% of the variability in a portfolio’s returns comes from asset allocation decisions—not stock picking. Yet, we tend to obsess over daily returns, checking our portfolios like a social media feed, celebrating when numbers go up and panicking when they dip.

But here’s the truth: chasing returns can give you a false sense of security. If you’re not paying attention to things like correlation, tail risk, and drawdowns, you could be setting yourself up for a major disappointment when the market takes a turn.

So, let’s shift the focus. Let’s talk about how to really evaluate your portfolio—the right way. That means understanding risk, market behavior, and making sure your allocation strategy is actually working for your long-term goals.

Key Takeaways

• Returns alone don’t tell the full story of your portfolio.
• Risk management, correlation, and drawdowns matter just as much—if not more.
• A well-diversified portfolio minimizes losses, not just maximizes gains.

1. Returns Are Just One Piece of the Puzzle

It’s easy to judge your portfolio by asking, How much did I make last year? But that’s like judging a car by how fast it can go without checking the brakes. 

Instead, ask yourself:

• How bumpy has the ride been? (Volatility matters)
• Are my investments actually diversified, or do they all move together?
• What’s the worst hit my portfolio has taken before recovering?

These questions give you a way better idea of whether your gains are sustainable or just temporary luck.

Hypothetical Example: Imagine two friends, Alex and Jordan. Alex’s portfolio steadily gains 10% per year with little drama, while Jordan’s jumps 20% one year and tanks 30% the next. Who’s better off? We think Alex, because avoiding major losses is key to long-term success.

2. Correlation: The Hidden Risk in Your Portfolio

A big mistake we see all the time is investors thinking they’re diversified when they’re not. They might hold 10 different stocks, but if they all tank at the same time during a downturn, that’s not real diversification.

Why Does Correlation Matter?

If your investments all move in the same direction, you’re at risk of big losses when the market turns. The key is holding a mix of assets that react differently to market changes.

Hypothetical Example:

• A tech-heavy portfolio might soar in a bull market but crash hard in a downturn.
• Adding diversifying securities bonds, real estate, and commodities can help smooth out the ride.

Tip: If you’re not sure how correlated your assets are, use a correlation matrix to analyze your holdings and find ways to diversify better.

3. Tail Risk: The Danger You Didn’t See Coming

Tail risk is what happens when the market throws a curveball—think 2008’s financial crisis or 2020’s COVID crash. These rare but brutal events can wipe out years of gains in a heartbeat.

How to Protect Yourself

• Hedge with defensive assets: Gold, bonds, and certain alternative investments are common defensive assets across investors.
• Use stop-loss strategies: Setting exit points can help limit your downside in risky assets.
• Consider options hedging (advanced): Protective puts or volatility index funds can shield you from major market crashes.

Ignoring tail risk is like driving without a seatbelt—you might be fine most days, but when something goes wrong, it really goes wrong.

4. Drawdowns: Why You Should Care About the Worst-Case Scenario

A drawdown is just a fancy way of saying, How much has my portfolio dropped from its peak before bouncing back? And trust me, this number matters more than you think.

Why? Because Recovering From Losses is Hard.

If your portfolio takes a 50% hit, you need a 100% gain just to get back to even. Ouch.

This is why avoiding big losses is just as important—if not more—than chasing big gains. Keeping an eye on drawdowns and making smart allocation decisions can help keep your portfolio on track.

5. The Right Way to Evaluate Your Portfolio

So, what should you actually be looking at when evaluating your investments? Here’s a more comprehensive framework:

• Risk-Adjusted Returns: Are you taking on too much risk for the returns you're getting? Check your Sharpe and Sortino Ratios.
• Correlation Check: Are your investments truly diversified, or will they all fall together in a downturn?
• Max Drawdown: How much has your portfolio lost at its worst, and can you stomach that kind of drop?
• Tail Risk Exposure: What happens to your portfolio during extreme market events?
• Liquidity Needs: Can you access your money without taking a massive loss if you need it?