Popular Allocation Approaches Put the Cart Before the Horse

    by James B. Cloonan

    I am amazed at all of the articles and Web pages devoted to “asset allocation.”

    While they all take the same general approach, they disagree strongly on the details. The general approach is to mandate that at a certain age, you should have a certain percentage of your wealth in each of stocks, bonds, cash, and sometimes other asset classes such as real estate. Sometimes they further divide each class into subclasses. For example, stocks might be divided into: large vs. small, domestic vs. foreign, or value vs. growth. They will then briefly mention that this reduces risk, but there will be no analysis of how it does this or proof that it works. The emphasis will be on the debate over whether a 50-year-old should have 50%, 60%, or 70% in equities.

    Most of the articles treat the topic as if asset allocation were an end in itself, rather than one possible tool in the creation of a portfolio that provides the highest return for a given level of risk. This is akin to arguing about the best road to take before you decide where it is you want to go.

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    → James B. Cloonan