The first new idea on asset allocation management is that buy-and-hold investing is a lot harder to pull off than you have been told.
Buy-and-hold investing makes sense. But the difficulty of buy-and-hold investing has been greatly understated.
Why? Because buy-and-hold investing became popular during the longest and strongest bull market in the history of the United States. Bull market psychology has influenced just about everything you have heard about buy-and-hold. You won’t know the full story until we have been in a serious bear market for a good bit of time.
Don’t wait for the bear market to adjust your asset allocation management strategies. Anticipate the adjustments you will be making when the bear market comes. Make those changes now, while you can still obtain good prices on any stocks you need to sell to bring yourself to a realistic long-term stock allocation.
The second new idea on asset allocation management is that it is a good thing to change your stock allocation as you learn more about how stocks really work.
Buy-and-hold investing requires that you stick with a general investing strategy for a long period of time. That’s fine, in general terms. It’s not reasonable, though, to expect to stick to a single strategy in all its details.
Why? Because you are learning new things about how to invest all the time. If you are doing things right, you should be a better-informed investor at age 30 than you were at age 20, and a better-informed investor at age 40 than you were at age 30, and so on. It would be crazy to give up the benefits of becoming better informed in deference to your desire to be a rigid buy-and-hold investor.
Your asset allocation management ideas should not be fixed in stone. Don’t make changes for no good reason. But accept from the beginning that some adjustments will be needed to reflect the learning process you will undergo as you become a more experienced investor.
The third new idea on asset allocation management is that ideas that are perceived as sensible in bull markets are not perceived as sensible during bear markets.
Investing is a tricky business. It’s in part about numbers. It’s in part about human psychology. During bull markets, people view stocks as being safer than they really are and as a result they focus on the numbers stuff. During bear markets, people view stocks as being more dangerous than they really are and as a result they focus on the psychology stuff.
Buy-and-hold investors experience both bull markets and bear markets during the course of their investing lifetimes. So they need to develop asset allocation management ideas that work in both sorts of markets.
Don’t take the bull market hype as. Accept the stuff that makes sense. Question the stuff that doesn’t seem to add up.
The fourth new idea on asset allocation management is that the worst strategic choice of all is to stick to a flawed strategy even after discovering that you went with too high a stock allocation.
If you are over-invested in stocks, you will feel tempted to go into denial when stock prices begin to fall. Don’t do it. You have probably enjoyed big gains during the bull market. The first price drop is likely not going to cancel out all of your gains. Swallow your medicine, make the necessary changes in your asset allocation management ideas, and get on with your life.
Denial will put you in a worse place. If you truly are over-invested in stocks at the beginning of a bear market, there’s a good chance that you will be selling somewhere down the line. It’s better to sell when prices are still not all that bad than to wait until they drop even lower. That’s real pain, a pain that can be avoided by being honest with yourself in the early days of a bear market as to any flaws in your initial asset allocation management ideas.
The fifth new idea on asset allocation management is that few investors are able to stick with the conventional strategies for any length of time.
Rick Ferri, author of All About Asset Allocation, offers his view on asset allocation management in a recent article in Smart Money magazine. Ferri says: “Behavior is by far the worst detriment to portfolio management. People sit down in an academic environment to study this, and they’ve done a good job. Of all those people, maybe 50% get to the point to take the next step and implement their allocation strategy. Many don’t actually implement it. It’s a kind of procrastination in getting it implemented. If it does get implemented, maybe 30% of those people will maintain the allocation after one rebalancing, one year. Something happens, they try to time the market or start chasing something, or believing the herd mentality…. By five years, of all the people who created an investment plan (30%) to begin with, maybe 10% of those actually follow through with their plan.”
Only one in three adopt an asset allocation strategy in accord with what the “experts” say. Of those, only one in ten stick with it.
That’s a sign that there is something seriously wrong with the conventional asset allocation management ideas. People listen to descriptions of the strategies. For some reason, though, the ideas do not take. Perhaps there is too much numbers mumbo-jumbo for the typical investor to make sense of. Perhaps the conventional strategies defy common sense in some respects.
The bottom line is that investors do not stick with these strategies. These strategies are not strategies that often work in the real world.
Perhaps you will be the one in ten who are able to stick with these strategies after adopting them. But the probabilities are otherwise. I don’t think that it’s a good idea to place too much confidence in your ability to beat the odds.
The sixth new idea on asset allocation management is that the key to developing a strategy that you can maintain for some time is integrating your investing goals with your life and work goals.
Investing experts like to write and talk about investing topics. That’s no surprise. That’s what you would expect.
It causes their advice to be less effective than it would be if they took a more holistic approach, however. If you begin worrying about losing your job, that’s going to affect how much risk you are willing to take in your asset allocation strategies. If your daughter expresses a desire to go to a private college in a few years, that may make you feel less comfortable with the idea of experiencing a big drop in portfolio value at a time a good many years before you plan to retire. Many people who say that they can afford to hold stocks through price drops that last 10 or 20 years are in reality in no position to do so.
Money is the fuel you use to pursue all of your most important life goals. Asset allocation management ideas that do not take non-investing realities into account are flawed asset allocation management ideas.
The seventh new idea on asset allocation management is that the effect of valuations must be taken into account in the development of your strategies.
Say that stock valuations are at moderate levels on the day you first develop your asset allocation plan. Say that, after assessing all of the factors that need to be considered, you determine that your stock allocation will be 50 percent.
Should your allocation remain at 50 percent when valuations go to high levels? I say “no.” Stocks do not offer as strong a value proposition at times of high valuation as they do at times of moderate valuation. If 50 percent was the right stock allocation at moderate valuations, then something less than 50 percent is the right stock allocation at high valuations.
It follows, of course, that an investor who determines that 50 percent is the right stock allocation at times of moderate valuations should be going with a stock allocation of something greater than 50 percent at times of low valuations.
Asset allocation management is risk management. Since the risk associated with stock investing rises with increases in valuation, the rational asset allocation management plan is the one that adjusts stock allocations up and down in response to changes in valuation levels.
Have you ever heard the recommendation that investors “Stay the Course!” with their asset allocation management plans? That’s generally good advice. Unfortunately, many investment advisors fail to detail what it means to “Stay the Course!” Are you really staying the course if you permit changes in valuation levels to increase the risk level of your stock allocation? Only according to the most hyper-technical and artificial interpretion of the phrase. To truly stay the course you set for yourself of taking on a specified level of risk, you must adjust your stock allocation in response to changes in valuation levels.
The eighth new idea on asset allocation management is that common sense counts for more than expert opinion.
One big problem we all face when engaging in asset allocation management is that we worry that we do not know what we need to know to set or change asset allocations effectively. There’s money involved. So we want to make good decisions. But we have non-investing jobs to do that take up most of our time. We can’t be experts at investing too. So we are inclined to defer to expert opinion on asset allocation management questions.
That’s not always such a good idea. Experts can offer good advice on many investing topics. But the most important thing with asset allocation management is not making so big a bet on stocks that you find yourself unable to maintain your asset allocation when prices drop. Only you know what sorts of losses you can sustain without feeling a sense of panic. You are the expert on what makes you tick. So you often need to tune the experts out and be guided by your own counsel.
This is especially so when stocks have been doing well for a number of years. Most experts greatly underreport the risks of stocks when prices are high. Why? Because many of their clients or readers do not like to hear about the downside of stock investing at times when prices are going up and they are trying to rationalize higher stock allocations. Many experts do what they do for money and often tailor their statements so as not to offend their most aggressive and least prudent readers and clients.
If it is your goal to adopt effective long-term asset allocation strategies, you often need to go against the grain of the most popular expert opinion of the time. You often need to go with higher stock allocations than what many experts advise during bear markets and with lower stock allocations than what many experts advise during bull markets.
You are the one who has to live with the results of your asset allocation management efforts. Inform yourself of what the experts say, by all means. But also listen to your gut, and don’t let expert opinion intimidate you into making asset allocation choices with which you do not feel comfortable.
The ninth new idea on asset allocation management is that lower stock allocations often generate larger long-term returns.
Stocks are a high-growth asset class. On paper, it often appears that those seeking strong long-term returns should be investing most of their money in stocks.
It’s not necessarily so.
Investing in stocks is a great way to grow your portfolio, to be sure. The key to great long-term returns, though, is to not only talk the buy-and-hold walk but also to walk the buy-and-hold walk. That means not being too greedy when setting your stock allocation.
Do tap into the juicy long-term returns offered to those who invest in stocks for the long run. But don’t overdo it. Go with too high a stock allocation, and you may end up selling stocks when prices head downward. That’s the worst possible thing you can do.
Those who go with lower stock allocations often end up realizing greater long-term returns in the real world.
The tenth new idea on asset allocation management is that your strategies need to be grounded in something objective.
There will be times when you will be tempted to abandon your asset allocation management plan. You need something strong to hold onto at those times to maintain your faith in your earlier decisions.
I suggest grounding your stock allocation decisions in what the historical stock-return data says about how stocks perform over the long term. The benefit of the historical data is that it is an objective source of insights.
The lessons of the historical data (presuming that the data is being analyzed properly) do not change from bull market to bear market or from bear market to bull market. The historical data always says the same thing,. The steadfastness of the historical data can be a source of reassurance at times when many of the experts are rewriting their asset allocation management advice.
The eleventh new idea on asset allocation management is that we don’t know it all yet.
The investing literature is anomalous. On the one hand, there are all sorts of books and articles and research papers exploring extremely detailed questions. On the other, there is often little consensus on the most fundamental questions.
Look over the technical stuff, and you will be inclined to believe that mankind’s knowledge of how to invest is well-developed indeed. Take a look at the differences of opinion evident in discussions of the most fundamental questions and you will be led to marvel at the lack of progress that we have made in unraveling the mysteries of investing.
It’s the fundamental stuff that matters most. It’s the fundamental stuff that drives analyses of technical questions. So the reality is that we have not advanced very far in our understanding of how to invest effectively for the long term.
The Financial Freedom Community has made some major advances during The Great Safe Withdrawal Rate Debate. But it would be a mistake to come to believe that we have it all figured out at this stage of the proceedings. We have unearthed some important clues as to how to invest successfully for the long run. But it’s important to keep in mind that there are more asset allocation management questions that remain unanswered today than there are asset allocation management questions for which we know for sure the right way to proceed.
Craft an asset allocation management strategy that you can stick with for the long term. But don’t write it in stone. Paradoxically, the true buy-and-hold investor is the investor who recognizes the need to maintain some flexibility in his or her asset allocation management plan.