Water Well Journal
Issue link: http://read.dmtmag.com/i/705618
I' m sure you've heard this before. If you have investments, the most important step you can take to ensure a healthy return is to allocate your assets correctly between equities (stocks) and fixed income investments (bonds, cash, and cash equivalents). Some financial advisers feel so strongly about the impor- tance of asset allocation, they say 90% of your total return over time depends on your investment mix between stocks, bonds, and cash—rather than your specific choices of the indi- vidual instruments in your portfolio. Some even suggest asset allocation affects 100% of returns over time. But not all denizens of the financial world are willing to accept this popular theory. While few, if any, are willing to say asset allocation is unimportant, some are suggesting per- sistent media publicity may have created a harmfully mislead- ing reputation for this basic investment technique. Here are some things you should know about this contro- versy—especially if you're in or approaching retirement. A Key Role While there is a lack of agreement on just how much of a role asset allocation plays in determining overall financial results, virtually all professionals agree it plays an important role in money management. A 1986 landmark study titled "Determinants of Portfolio Performance" by Gary Brinson, L. Randolph Hood, and Gilbert Beebower illustrated this point. It concluded asset allocation explained more than 93% of the variation in an investment manager's average returns over time. Brinson and Beebower, joined by Brian Singer, largely reaffirmed these conclusions in 1991 in an update to the 1986 study. Later, in their 1999 paper "Does Asset Allocation Explain 40%, 90%, or 100% of Performance?" Roger Ibbotson and Paul Kaplan concluded asset allocation on average explains 100% of returns over time and 90% of the variability of returns over time. In rebuttal to the paper, the former head of Wells Fargo Investment Advisors, William Jahnke, asserted: Asset allocation explains nearly 100% of portfolio performance only in the absence of active security selections and the conscious timing of trades. If one does not index but instead makes individual security selections and also attempts to time market moves, then asset allocation accounts for far less of the overall portfolio performance. So now you have a "clear" idea about how much of your return will be affected by asset allocation. Right? In truth, your guess as to the specifics will probably be as good as those of the experts. In fact, the whole issue is so muddled an entire industry has been built around it. Do a Google search on "asset allocation" and you'll get 6 million hits. You won't have to dig far into those results to find sites that will—for a fee—design an asset allocation customized for you. Obviously, there is disagreement among the experts as to the exact degree asset allocation will affect the return on your portfolio. True, but virtually all professionals agree it should be part of every investment portfolio. Some Suggestions Well then, how do you go about designing your own allo- cation model? First, let's begin with a reminder of what asset allocation is all about. Most portfolios consist of • Equities (stocks) • Fixed income investments (bonds, cash, cash equivalents such as CDs) • Treasury bills. How much of your total portfolio to allocate to each of these categories is the challenge of effective asset allocation. There are no definitive guidelines telling you what alloca- tion model is best for you. Each of us has a different set of variables to consider—such as tolerance for risk and age. But there are suggestions that can help you decide. One rule of thumb that's been around for a long time sug- gests you should subtract your age from 100. The result is the percentage of your portfolio you should keep in stocks. So for example, if you're 30, you should keep 70% of your portfolio in stocks. If you're 70, you should keep 30% of your portfolio in stocks. The rest is allocated equally between bonds and cash. However, with life expectancy creeping upwards, many financial professionals are recommending the rule be raised to 110 or even 120 minus your age. An article in Forbes goes WILLIAM J. LYNOTT YOUR MONEY ASSET ALLOCATION It takes effort, but it's a necessity for your portfolio. waterwelljournal.com Help is available. A number of companies provide free online asset calculators . 50 August 2016 WWJ