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Layman's explanation of Asset Allocation.,
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This review is from: All About Asset Allocation, Second Edition (Paperback)
Asset Allocation is the latest craze in financial/investment planning. As an experienced investor who frequently out performs the S&P500, which means the bulk of financial planners/fund managers, which means the basic premise of this and most other investment books, I have 2 distinct views. Please read both before assessing me or this book.
Investments boil down to risk versus the expected reward. Generally, for credible investment vehicles, for a greater return (reward), one must expect greater volatility and instability (Real definition of risk.). If the timing in one's life is inconvenient, one can find themselves having to liquidate a very volatile investment at the worst possible moment; i.e. 12/08. Asset allocation is a plan to spread one's portfolio over a spectrum of investment vehicles to greatly reduce the risk, yet still reap most of the rewards. NOTE: risk is 'not' the probability that one might lose money.
Now, there are 3 critical premises to this concept that must be understood. These premises also shape the 'dual' nature of my review. These premises also severely shape the success of this entire concept. (1) The model was developed by grad students as a research project. By definition they had to make very simplistic assumptions, to limit the scope of their project, and to get a manageable result. That means the financial world is far more complex in reality. (2) One big assumption is that one can not do any better than the long term return of the S&P500. Every broker, financial planner, and investment book presents that as the standard. It is not true. It is merely simplistic. Actually for financial planners it is pure criminal laziness. (3) Asset allocation in its present form, assumes that the investor will not read, comprehend, or adjust to any economic events or news, during their entire investment life. For example, learning that the US economy was built on a house of financial instrument cards and that there is little to no wealth building enterprises left in this country; apparently means nothing to the average investor. Therefore, he/she will continue to maintain a 70% allocation in large cap US stocks, even while 2 major automakers file for bankruptcy.
Now my review. It turns out that most investors actually operate on premise number 3 above. Secondly most investors confuse the probability that they might lose money with the definition of risk. Thus, they invariably react exactly the opposite of their best interests in both great times and disaster. Most investors do not have the inclination to spend much time at all, if any, understanding how investments work, wealth is built, or calculating what their needs are or will be. For this kind of investor, asset allocation, even in its simplistic popular form, will work very well for them. This book is written at a technical level that is perfect for the average investor who wants to put away a sizable nest egg for their future. The allocation models, advice, and discussions, within this book, will work adequately over the long term for the above class of investor. So I highly recommend this book on that basis.
Then there are the relative minority of investors who actively become involved in their portfolios. For a person who reads, comprehends, and is able to modestly predict the consequences of major geopolitical and economic events, contemporary asset allocation is severely flawed. Following the suggestions in this book, or any other on this topic that I have read, will doom the reader to mediocre returns and dozens of missed opportunities over a life time. I predict that a person will end up with a fraction of the total accumulation of wealth that is available, by simply 'not' keeping abreast of current events. i.e. In 2008, when it was apparent that the US economy was built on a house of cards, simply reallocating a sizable chunk of one's portfolio to documented and proven strong economies (BRIC: Brazil, Russia, India, China) would have avoided sizable losses and replaced them with dramatic gains. And, it did not take rocket science for a lay person to understand that. Or, a stimulus plan that simply prints worthless paper money, to be spent on government workers bonuses and salaries, is not going to lead to a long term robust wealth building economy.
My second and negative opinion having been stated, I would still recommend this book, Edelman's "Lies about money", or other readable books on the topic. The basic concept is not a waste of time. If one understands the limitations of the premises that were made during asset allocation's conception, there is still a great deal of value to be gleaned from the idea. This book is quite readable, especially to a non-technical person. So, combining the simplistic concepts with some reason and basic common sense in today's world, I believe an investor can still extract a wealth of understanding from this book. And, that person can profit from that allocation knowledge.
Therefore 4 stars overall, 3 for the experience investor, 5 for the majority.
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Showing 1-9 of 9 posts in this discussion
Initial post: Jan 16, 2011 8:41:32 AM PST
Last edited by the author on Jan 16, 2011 11:14:18 AM PST
Rick Ferri says:
It's not the buy and hold investor who will "be doomed to mediocre returns", it's the overconfident investor who believes there are "opportunities over a life time" to make profitable market-timing decisions. They are the investors who suffer the worst returns. Every study on investor behavior proves this.
The truth is that people think they are better drivers, better dressers, better lovers, and better investors than they actually are. They think they can beat the markets, but most can't and don't. The few investors that do win in the long-term tend to be lucky, not skillful. Stick with what works; an asset allocation that matches your needs that's invested in very low-cost index funds and ETFs.
In reply to an earlier post on Jan 16, 2011 3:07:00 PM PST
Last edited by the author on Jan 16, 2011 3:08:35 PM PST
In reply to an earlier post on Mar 2, 2011 7:19:18 AM PST
Last edited by the author on Mar 2, 2011 7:22:12 AM PST
Rick Ferri says:
G. Laird wrote, "I said that 1 premise assumed that the best returns possible were those of the S&P500."
G. Laird, respectfully, there is NO place in the book where this statement is made or inferred.
Also, your statement that "one ought to consider great geopolitical and financial events as a factor in that allocation" is the exact type of market guessing that gets people into trouble. Doing this assumes superior knowledge and understanding of geopolitical and financial events as well as superior skill in designing and implementing a strategy around them, neither of which 99.9% of investors have.
In reply to an earlier post on Mar 2, 2011 9:33:05 AM PST
Okay, I'll take Mr. Ferri's word for it that he didn't explicitly state the maximum possible return was that of the S&P500. My initial statement to that effect, concern the underlying premise for the 'asset allocation project' and current presentations, there of. I do not believe that he went out of his way to refute that premise either.
I see the possibility for misunderstanding when we each try to interpret "buy & hold strategies", my use of "mediocre returns", "market timing" versus my use of "adjusting allocations".
To clear the air on my opinion. There is great value in Mr. Ferri's book, as I said in my initial post. But, the basic concept was based on a limited or restricted premises, made by the authors of the initial project. The industry and just about every author I have read to date, does not make much attempt, if at all, to go beyond those premises. The value in this book is the notion that one can and should allocate assets and ways to do that.
Now back to addressing contradictions. I absolutely agree that market or stock timing almost never works. In 35 years, I have encountered people who by luck or skill caught a major inflection point. Only to completely miss the opposite point a short time later. I have yet to see a timing scheme of any sort that even is rational, let alone likely to succeed. My proposal to periodically adjust allocations based on major current events, is not "market timing". In practice, in my own portfolio, it results in about 5% of the portfolio being shifted once every 3 or 6 months.
However, I also do not agree with the opposite extreme, which the words "buy and hold" can construe. That is, set up some pie sliced allocation. Stick with it. Adjust it only for factors like age or risk or other minor event. That definitely, from a large statistical sample in my observation, will lead to mediocre or worse results. The reason being, major events that change the investment arena and the world do occur. They are occurring with more frequency. My assertion, that no author, including Mr. Ferri, directly address, is that by simply staying abreast of current events and internalizing them in one's allocation strategy; an investor can greatly improve one's life time returns. I have done it, over the last 20 years. I have watch others do it. It is not just luck.
Now, I do have to focus on Mr. Ferri's last comment that considering major events can possibly lead to trouble. 1st, that statement contains an imbedded premise that "average investor" is unable to interpret major events. I guess the 07-08 mortgage/financial industry crisis was beyond anyone's understanding. Therefore, holding a large allocation of GM, Chrysler, Lehman brothers would have been wise allocation strategy, right through 2010? Or, the opposite; seeing Asia take almost all of the US core wealth building industry and jobs, leading to a sustained economic growth of 5%+, would tell an average investor to stay pat with a 60-90% allocation in US stocks. And avoid those dangerous "emerging markets" as a sizable slice of the allocation pie? Readers decide.
Now, please return to my original post. I did note the observed statistic that most investors, for whatever reason, do not actively participate in their investments. I also stated that the strategies listed in Mr. Ferri's book would successfully work (I will now add the words "taken verbatim".) and produce what I consider mediocre but sufficient life time returns.
So we do disagree on some critical points. But I have and still recommend that readers read "All About Asset Allocation". I think they will get more out the book, by considering my criticisms.
Posted on Jan 18, 2013 10:12:23 AM PST
D. Newell says:
As one who is anticipating retirement here shortly I have been besieged with companies wanting my Pension to manage, for fees ranging from .50 % to 1.50 %. All of them subscribe to the Modern Portfolio Theory when it comes to asset allocation. There were things about this theory that bothered me but I could not put my finger on exactly why. This posting by G. Laird nailed it for me. You put in words, what I had trouble defining for myself. Basing future investment allocations based on past premises on equities and bonds seems to be a minefield of sorts. I would love to explore what you are currently doing yourself as opposed to signing on with someone who would manage my money based on Asset Allocation.
In reply to an earlier post on Jan 18, 2013 12:29:48 PM PST
Quick assertions of my M.O.:
1) I do subscribe to the theory of Asset Allocation. In fact, during the turmoil of the last 12-18 months, it saved my bacon.
2) The caveat that motivated my objections to Ferri's book, was that one cannot reasonable assess global/national/regional economic conditions that would affect major sectors or world regions. That is hooey. In fact, I noted that Asia would become dominant ~08, and shifted 65% of my portfolio to those targeted funds. Then I noted the growing turmoil and over extension of the Chinese markets, coupled with a the lackluster growth of the US, and shifted ~20% my portfolio out of chinese funds and into world/US funds.
3) Paid brokerage advisers are cowardly hacks. They cannot take even reasonable risk, nor set in place reasonable tools, like stops, for fear of making a mistake and ticking off their customers. Ergo, their clients are doomed to have mediocre returns, stuck in a "safe" buy & hold US large cap dinosaur portfolio.
4) Apparently 7 out of 10 mutual funds are managed the same way.
5) But, 3 out of 10 are not. It doesn't take rocket science to use any brokerage mutual fund scanner, to look for sustained performance during good years and "BAD", to identify which managers seem to consistently out perform their peers and the major indexes. Every 3-6 months I review how they are doing, and if they slip consistently, I fire that fund manager and find another.
I just reviewed the funds in my portfolio. Several I have held since the 90's. Of the 18 or so, that form my allocation, 12-15 have consistently out performed their peers and the indexes for 3 or more years.
Since I cannot find any paid "manager" at any price who will volunteer this expertise in selection, nor take the risk (by being compensated by performance instead of size of assets under management), I am forced to do it myself.
To add one last note, in Mr. Ferri's favor and the theory of Asset Allocation. Starting in 09, who would have thought that over 1 or 2 year segments, bonds and/or real estate would out perform traditional funds? I would not have guessed so. But I allocated a chunk of my portfolio to those asset classes anyway. They are among my consistent high performers.
In reply to an earlier post on Jan 18, 2013 2:23:15 PM PST
D. Newell says:
Dear G. Laird, Thank you for your prompt response. I have been involved with buying and selling stocks and both leveraged and inverse ETFs. Additionally the bulk of my account is in a brokerage account where I sell Options on the Big S and P futures. That has worked reasonably well for the past 5 years or so. I say this to merely demonstrate that I am not a neophyte per se in investing and trading. But I have not had the amount of money that I am about to possess as a result of this upcoming retirement. To try and figure out what to do with a million plus in pension money is a bit daunting to me. I guess my plan of attack now, is to read some of the books that were recommended on the Boglehead forum, such as Bodlehead's Guide to Investing, The Coffee House Investor, All About Asset Allocation (Ferri), Four Pillars of Investing and the The Little Book of Common Sense Investing. I have attended seminars by a number of companies who want to manage my money for me (including Richard Ferri). So your point numbers 3) and 4) really got my attention!
So if I understand you correctly and drawing from what I think asset allocation is I presume that you determine what asset classes you want to be invested in. You also determine what per cent of those asset classes would be appropriate for your portfolio. Then it would seem, that you comb the universe of funds that are the best long term players in those particular asset classes. You don't for instance, go to Vanguard and chose from among their family of funds alone which funds you want to have in your portfolio.
Do I have this essentially right or am I missing something? Any thoughts on the books above? Or the game plan itself?
Any additional help will be greatly appreciated. I tend to lean towards the direction you seem to be taking... but it is very anti conventional to manage things like this yourself at this level.
PS would an email exchange be better , is does this work for you?
In reply to an earlier post on Jan 18, 2013 2:52:09 PM PST
I think you have encapsulated my strategy, as best as one can articulate something that does evolve a bit, over time. I experimented with ETF's for a time. I realized that my best chance of superior performance was to gamble on actively managed mutual funds. I've held this view off and on over 30 years. As it turns out, I'm back into actively managed mutual funds currently.
I have severe objections to Mr. Bogle. See my criticism of his book. And through any ETF scanner, one should find that Vanguard has not stood the overall test of time.
I haven't read a majority of the titles you mentioned. I have found that no particular book provides a solid foundation for a investment strategy. They all have flaws of prideful authors, particular products that are offered for sale, arcane advice that has not stood the test of time, etc. But in each book, there may be a few nuggets of wisdom that adds to the whole of investment knowledge, or "feel" for the world of investing.
In reply to an earlier post on Aug 11, 2013 5:24:25 AM PDT
Rick, Sir, we just love your straightforward no-nonsense style; simply top-notch! Thanks Rick.
John A Tirone
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