What the investment industry does not want you to know, by William J. Bernstein

William Bernstein_Sweat Your Assets

If you want to know the biggest determinant of your future investment returns, I would suggest you look at your asset allocation. If you are looking for a powerful and witty introduction to the subject, makes sure to read these notes on Portfolio Theory by William J. Bernstein, one of my favourite financial authors.  

It’s a fact: you can positively impact only one aspect of investment performance: your allocation of assets among broad asset classes. Stock or mutual fund picking and market timing, the things traditionally thought to be critical to investment success, turn out to be almost irrelevant. How can this be?

Over 10 years ago, Gary Brinson, a noted finance academic and money manager, studied a group of pension fund managers. He found that he could explain over 90% of the differences in variability among these investment professionals simply by classifying them according to how much of their assets they placed in stocks, bonds, or cash. Stock picking or market timing skill? Try as though he might, he found no evidence of either among these investors practising their craft at the apex of the profession. The significance of this for small investors is profound: find the “right” mix of foreign and domestic stocks and bonds, and your choice of individual securities becomes almost irrelevant in the long run.

How the investor arrives at the “right” mix is called “portfolio theory,” and until recently small investors had precious little guidance in this vitally important area. How difficult is it to find the “right” mix? Surprisingly easy. Consider this: If over the past 10 or 20 years you had simply held a portfolio consisting of one quarter each of indexes of large U.S. stocks, small U.S. stocks, foreign stocks and high-quality U.S. bonds, you would have beaten over 90% of all professional money managers and with considerably less risk. The amazing truth is that over a long enough time period almost any reasonably balanced indexed strategy will best the overwhelming majority of “professional” managers.

Asset allocation: the basics

Sadly, most investment information available on the Web falls into the category of “financial pornography: the supposition that investing success is achieved by predicting the direction of the market and picking the right stocks. In turn, it is supposed that this can be accomplished by engaging the services of a select group of investment professionals (of which the interviewed/quoted analyst/newsletter writer is a member). Almost no electronic ink is devoted to what turns out to be the main event: asset allocation. The Web is not entirely devoid of worthwhile material.

If you really want to become proficient at asset allocation you are going to have to log off the ‘net, power down your computer, and go to the bookstore or library and spend several dozen hours reading books.

There are at least two books on asset allocation available:

  • Investing for the 21st Century. An educational and entertaining investing primer by Frank Armstrong, a Miami financial advisor. Hopefully, after reading this you’ll never listen to another financial commentator.

  • The Intelligent Asset Allocator. It’s written by yours truly [W.J. Bernstein], so I can’t impartially review it.

For those who are interested in further reading, I have put together a structured study guide and reading list. No pain, no gain. Don’t shoot me, I’m only the messenger.

Call to Action

Make the best of Bernstein’s analysis, watch out for financial porn, and make the necessary to time to study Asset Allocation/Portfolio theory. These are three articles that cover Asset allocation of three great Investors:

 

The Best Investment Portfolio. Benjamin Graham Portfolio for the Defensive Investor

–  The Best Investment Portfolio. David Swensen

The Best Investment Portfolio. Rai Dalio’s All Weather Portfolio

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