Asset Allocation's Death "Greatly Exaggerated"

September 28, 2009
Jerry Miccolis

Asset allocation is still the only scientifically-validated method to win the investment game. For more on reports of its death, see: Mark Twain.

When I hear claims that asset allocation is “dead,” I think of Mark Twain’s quip about his untimely obituary: “The report of my death was an exaggeration.”

Call off the funeral. Asset allocation is alive and well—and still the only scientifically validated method to win in the investment game over the long run.

Some people have given up on asset allocation because it didn’t prevent investors from losing money in the recent financial meltdown—though it softened the blow.

Other strategies, like market timing, can occasionally give you a better result in the short run, but only by chance. It’s smarter to base your investment strategy on a sound, time-tested science rather than rolling the dice. Asset allocation didn’t fail: it’s not designed to protect your portfolio from short-term losses. It’s designed to give you the best long-term expected return for the risk level you can tolerate.

By spreading your investments among such asset classes as stocks, bonds, real estate, and commodities, asset allocation reduces portfolio volatility, which eats into returns. But, since your assets will not all grow at the same rate, your portfolio needs to be monitored to make sure it stays true to your desired allocation.

Going Against Your Instincts Makes It Work

The key is to rebalance—not on a fixed schedule, but opportunistically, when your allocations get materially out of whack. This means selling some of your “winners,” and buying more of your “losers.”

That goes against intuition—the natural feeling to keep playing a winning hand. That emotion is why so many investors consistently underperform the market indexes. And it explains why so many found themselves under-allocated to stocks and missed out on this year’s huge run-up since the market bottom.

Opportunistic rebalancing forces you to ignore your emotions and systematically “sell high and buy low.” It both keeps your allocation on track and produces higher returns with less risk over the long haul.

Winston Churchill once said “democracy is the worst form of government except all the others that have been tried.” That quote gives perspective to those writing death notices for asset allocation. Asset allocation is an imperfect system, but it’s miles ahead of whatever’s in second place.

Jerry Miccolis, CFA, CFP, is a senior financial advisor and co-owner of Brinton Eaton Wealth Advisors, a fee-only investment management, tax advisory and financial planning firm in Madison, N.J., serving individuals and institutions throughout the US. He is also coauthor of Asset Allocation For Dummies, (Wiley, 2009). He can be reached at miccolis@brintoneaton.com.