In any stock market climate, proper asset allocation matters. In a
down market, you could argue that it matters more than anything else.
Did you have a well-diversified portfolio during the fall of 2008? That was a
time when the importance of having a bond allocation and proper equity
diversification really hit home. Nearly all investors were hit hard, but some
were hit harder than others. What percentage of your portfolio was held in
Treasuries (or cash) at that time?
Wise asset allocation may help you as the market recovers. Yes, even
diversified portfolios lost money at the end of 2008 and the start of 2009. Yet
with rebalancing, these same portfolios may be poised to take advantage of a
You might say there are two schools of thought when it comes to diversification
and asset allocation – hands off, and hands on.
Modern Portfolio Theory. In 1952, a University of Chicago Ph.D. candidate
named Harry Markowitz published a thesis - a brief, provocative paper that
called for investors and money managers to see risk with new eyes. That was the
start of Modern Portfolio Theory, which still has many advocates today.
Before MPT, money managers and investors tended to look at investments in
isolation: if a stock had performed well in 1948, it was a good stock and it
would probably perform well in 1949. They analyzed a stock almost like they
would analyze a business.
In his paper, Markowitz basically said “You guys are going about this the wrong
way.” He first assumed that all investors wanted to avoid risk (which he defined
as standard deviation from expected portfolio returns). He then contended that
you should measure the risk level of a whole portfolio instead of individual
securities.1 (In other words, if you want to include a security in your
portfolio, you should think about how that will alter the risk level of your
entire portfolio, rather than simply consider the risk of the security.)
MPT asserts that for every portfolio, there exists an “efficient frontier” – an
ideal asset allocation among diversified asset classes that should efficiently
balance maximum return and minimum risk.2 Markowitz further developed the theory
with economists Merton Miller and William Sharpe, and it eventually won a Nobel
Prize in economics.
MPT has its fans – but also its critics. In the last 20 years or so, many
investment advisors and money managers have practiced a buy-and-hold style of
portfolio management using the diversification principles of MPT. But as the
markets dropped in 2008-09, critics pointed out the danger of buying and holding
- you can “hold” positions too long. In the crisis, some investment advisors
took more of a hands-on approach to portfolio management – others had always
How long is the long run? If history is any guide (and it may not be),
the longer your investment horizon, the more sense buy-and-hold can make – at
least when it comes to stocks. For example, $1 invested in stocks in 1929 would
be worth $759 in 2009, whereas $1 invested in bonds in 1929 would only be worth
$74 today. The critics counter that argument with the fact that the S&P 500
traded at the same level in mid-2009 as it did in summer 1997. Stretch or
contract different windows of time and you can reach all kinds of conclusions.2
The bottom line. The buy-and-hold adherents and critics certainly agree
on one thing: diversification is hugely important. If your assets are allocated
across 10 or 12 “baskets” instead of one or two, for example, you are
theoretically less affected by the whims of the financial markets.
So what is “proper” asset allocation for you? Only you and your financial
advisor can determine that. Your time horizon, preferred investment style,
accumulated assets, life goals and financial objectives – these all have to be
taken into consideration. It’s worth a conversation, today.
Diversification does not guarantee against loss; it is a method used to help
manage investment risk.
These are the views of Peter Montoya Inc., not the named Representative nor Broker/Dealer, and should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information..