Investment Advice – How the Smart Money Invests
Asset Allocation – the smart strategy to construct your portfolio
Many people still cling to the belief that the best way to manage their money is to either pick stocks themselves or pay stock brokers or mutual fund managers who only result in doing a substandard job. However, for many years, the wealthy and sophisticated investors with the means to hire the most elite money managers have achieved superior returns with a very different method of investing that was developed by Economics and Finance Nobel Laureates. This method is broadly knows as “Modern Portfolio Theory,” and the key to its success lies in the use of asset allocation. Harry Markowitz is considered the father of Modern Portfolio Theory, and won the Nobel Prize for this work. Since that time, numerous other academics have provided research in the area, many becoming Nobel Laureates in the process.
Asset allocation is the process of splitting up your investment money in to types of investments, to create an overall portfolio that seeks to minimize risk and maximize returns. While many people believe it’s all about which stocks you own, the truth is that investment success is more dependent on which “asset classes” you choose.
For example, in the world of finance, the 1986 Brinson Study “Determinants of Portfolio Performance” is often cited as the case for asset allocation. This study determined that greater than 91 percent of portfolio performance comes from portfolio design (asset allocation) while less than 10 percent of performance is derived from individual security selection and other factors.
In building our portfolios, we use the theories and methods of some of the smartest finance people in the world. Many investors simply have not had access to these investment methods because the tools for structuring, managing and rebalancing an ETF or passive asset class fund portfolio have not been readily available or affordable. Stock brokers and commission based advisors do not use these investments for their clients, because they do not pay commissions to the broker.
We do not use individual stocks, or commission based load mutual funds in our portfolios. We use only ETF’s or no commission passive asset class index funds. Why? Several reasons. First, when you own an individual stock, you have no control over bad news or unexpected events that can destroy the value of your investment over night (think, Enron, Worldcom, Bear Stearns, Wachovia, Washington Mutual, Lehman Brothers, BP and a host of others). Why take that risk. When we build a portfolio with asset classes, each “class” might be comprised by an ETF or index fund that owns hundreds of stocks. Bad news for a couple contained in the fund would be nearly meaningless to your portfolio. Also, by owning entire classes of assets, we can direct money to specific sectors or areas that are experiencing strength as a group.