Skip to main content

Sound Advice: January 13, 2021

Why Asset Allocation is Important

Although asset allocation and diversification are words that are regularly used when thinking about proper portfolio construction, more often than not lip service is not followed by actual attention to the process of putting together a grouping of investments that makes sense.  What makes sense is a collection of securities within a variety of asset classes with the objective of gaining worthwhile returns while limiting risk exposure.

It's not hard to do.

One traditional approach to asset allocation has been a 60/40 split between stocks and bonds, decreasing the percentage allocation to equities as investors get older.  This has not been a bad way to go, but simply thinking in terms of U.S. stocks and bonds overlooks the opportunities available by considering a wider variety of asset classes, including international stocks, real estate, and high yield (a.k.a., junk) bonds.

A few years ago, I completed a study of asset class returns from 1989 thru August 31, 2017 that was quite telling.  In that study, I reviewed the yearly returns, the volatility of returns (standard deviation), and the number of negative returns over the period.  The asset classes included were growth stocks, value stocks, large cap stocks, small cap stocks, developed country stocks, emerging markets stocks, investment grade bonds, high yield bonds, real estate stocks, and commodities.

Here are the results:

The highest annual returns, by far, over the 28-year period were from emerging markets stocks: 16.0%.  BUT, those returns were accompanied by two and half times the volatility of the average of all asset classes.  What's more, for this asset class, 12 of the 28 years showed losses, one in excess of 50%.

Four of the asset classes (growth stocks, large cap stocks, value stocks, and real estate stocks) provided returns in the 11.5-12.0% range, though here too the volatility was still 30% higher than the average of all asset classes. For this group, there were five down years over the period.

The weakest returns were provided by investment grade bonds, which averaged gains of 7.0% annually and had only three down years.  Even so, that performance may not be indicative of the future for this asset class since bonds had a four-decade rally from 1980 on as interest rates plunged from the mid teens to near zero in the wake of the Great Recession of 2008-9. Going forward, it’s likely interest rates will rise and bond prices will fall.  Not an encouraging prospect.

A simple solution worth considering would be to construct a portfolio with equal percentages allocated to each of the 10 asset classes.  For the period considered, the annual returns would have been 10.2% with overall volatility lower than all asset classes other than investment grade bonds.  Taking this one step further, one might well choose to stay away from commodities, in which case annual returns would have increased by 0.5% without a significant jump in risk.

Although there are numerous combinations of asset classes that are probably worth considering (and potentially more profitable), the key point is that with this kind of real diversification it's quite likely that worthwhile gains will accrue while dampening risk significantly.

Any questions?  Please contact me at nrwayne@soundasset.com

N. Russell Wayne, CFP®

Sound Asset Management Inc.

Weston, CT  06883

203-222-9370

www.soundasset.com

www.soundasset.blogspot.com

Comments

Post a Comment

Popular posts from this blog

Sound Advice: January 3, 2025

2025 Market Forecasts: Stupidity Taken To An Extreme   If you know anything about stock market performance, you can only gag at the nonsense “esteemed forecasters” are now putting forth about the prospective path of stocks in the year ahead.   Our cousins in the UK would call this rubbish.   I would not be as kind. Leading the Ship of Fools is the forecast from the Chief Investment Strategist at Oppenheimer who is looking for a year-end 2025 level for the Standard & Poor’s Index of 7,100, a whopping 21% increase from the most recent standing.   Indeed, most of these folks are looking for double-digit gains.   Only two expect stocks to weaken. In the last 30 years, the market has risen by more than 20% only 15 times.   The exceptional span during that time was 1996-1999, which accounted for four of those jumps.   What followed in 2000 through 2002 was the polar opposite: 2000:      -9.1% 2001:     -11.9% ...
Post a Comment
Read more

Sound Advice: January 15, 2025

Why investors shouldn't pay attention to Wall Street forecasts   Investors shouldn't pay attention to Wall Street forecasts for several compelling reasons: Poor accuracy Wall Street forecasts have a terrible track record of accuracy. Studies show that their predictions are often no better than random chance, with accuracy rates as low as 47%   Some prominent analysts even perform worse, with accuracy ratings as low as 35% Consistent overestimation Analysts consistently overestimate earnings growth, predicting 10-12%                 annual growth when the reality is closer to 6%.   This overoptimism can                 lead investors to make overly aggressive bets in the market. Inability to predict unpredictable events The stock market is influenced by numerous unpredictable factors, including geopolitical events, technological changes, and company-specific news.   Anal...
Post a Comment
Read more

Sound Advice: October 12, 2022

More Pain Ahead? It’s been a difficult year for the investment markets, but tough times have happened before and they will certainly happen again.   Sometimes recoveries are relatively quick and sometimes a hefty dose of patience is required.   No two downdrafts are alike, but the net result is always a rebound to even higher levels than seen before. One of the most uncomfortable stretches over the last half century took place during the oil embargo days of the early and mid-1970s.   Market valuations fell to the high single digits, a level that was about half the historic average.   For investors, this was one of the great sales of all time.   Those who had the courage to get aboard reaped huge rewards. More recent pullbacks of note took place during the dot.com days of the turn of the millennium and the banking crisis of 2008-9.   The former period was marked by what appeared to be investors’ absolute indifference to longstanding measures of reasona...
Post a Comment
Read more