Wiki comments requested: The importance of asset allocation

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Wiki comments requested: The importance of asset allocation

Post by LadyGeek » Thu Jan 29, 2015 8:21 pm

On several wiki pages, such as Asset allocation and Risk and return: an introduction, we make a very bold statement:

ImageAsset allocation is one of the most important decisions that investors can make. In other words, the importance of an investor's selection of individual securities is insignificant compared to the way the investor allocates their assets to stocks, bonds, and cash equivalents.

An important statement such as this should cite a credible source, but none is to be found. In order to provide a credible source, the statement has been modified on our sister Canadian website (Asset allocation - finiki, the Canadian financial wiki) to:*

ImageAsset allocation is one of the most important decisions that investors can make. William F. Sharpe writes "It is widely agreed that asset allocation accounts for a large part of the variability in the return on a typical investor's portfolio."[1]

1. Sharpe, William F., Asset Allocation: Management Style and Performance Measurement, Reprinted from the Journal of Portfolio Management, Winter 1992, pp. 7-19. Viewed January 5, 2015

The content of the notice has become a point of contention between several wiki editors, as we want to make sure it is both clear and verifiable. So far, we haven't been able to come to an agreement, so I'm throwing this out to the general forum for opinions.

First question: Which version do you think is more appropriate (and easier to understand) for new investors?

Second question: Is there a better way to phrase this statement? Can you support it with reliable sources?

New investors are especially encouraged to participate in the discussion.

* This is a collaborative effort between the editors of the Bogleheads wiki and our Canadian sister wiki, finiki, the Canadian financial wiki
====================================================================================
Additional source possibilities: John Bogle's The Riddle of Performance Attribution: Who's In Charge Here—Asset Allocation or Cost?, Ibbotson's The Importance of Asset Allocation, and Setting the Record Straight on Asset Allocation.

This discussion is also posted at our sister Canadian website Financial Wisdom Forum: Wiki input requested: The importance of asset allocation
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Re: Wiki comments requested: The importance of asset allocat

Post by Triple digit golfer » Thu Jan 29, 2015 8:35 pm

I like the first one better.

It is good as is, but if I were picky, I would recommend phrasing it something like this:

Asset allocation is one of the most important decisions an investor must make, having a significant impact on one's investment risk and return. How an investor allocates between stocks, bonds, and cash is more important than the individual securities selected among those asset classes.

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Re: Wiki comments requested: The importance of asset allocat

Post by richard » Thu Jan 29, 2015 9:06 pm

The importance of asset allocation versus security selection seems to be very contentious, with much written on the subject.

Here's a sample paper on the subject http://www.cfapubs.org/doi/pdf/10.2469/ipmn.v2011.n1.5 If you believe the paper, it's about 2/3 allocation, 1/3 selection. The citations in the paper offer other views. Google "asset allocation vs. security selection their relative importance" for more sources.

I believe "insignificant" in the first version is too extreme. I also regard Sharpe as a very reliable source, so I'd go with his version if those are the only choices.

Given the controversy, I don't see why we have to choose relative importance. I'd prefer:

"Asset allocation is one of the most important decisions that investors can make. We recommend that investors first decide on an asset allocation, then implement that allocation with carefully chosen funds or securities."

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Re: Wiki comments requested: The importance of asset allocat

Post by LadyGeek » Thu Jan 29, 2015 9:24 pm

There are no restrictions on the choices, as we're questioning both versions.

I read your paper* and did the google search. You're right, there is a lot to say on the subject. Your paper has one result, Setting the Record Straight on Asset Allocation (in my first post) says 90% is due to asset allocation.

richard wrote:"Asset allocation is one of the most important decisions that investors can make. We recommend that investors first decide on an asset allocation, then implement that allocation with carefully chosen funds or securities."

How would the first sentence be verified (which sources to use, perhaps Sharpe)? The second sentence "We recommend..." is a forum consensus.

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Re: Wiki comments requested: The importance of asset allocat

Post by kmok » Thu Jan 29, 2015 9:29 pm

Maybe these quotes should be considered:

"in the late nineteen eighties, Gary Brinson, a noted money manager and financial analyst and his colleagues published two sophisticated statistical studies of eighty two large pension funds, but concluded that asset allocation accounted for over ninety percent of the return variability among the funds with less than ten percent contribution from market timing and actual stock and bond selection. In other words, asset allocation policy was ten times as important as stockpicking and market timing combined" William Bernstein, the Intelligent Asset Allocator

"Market timing and security selection are obviously important. The problem is that nobody achieves long-term success in the former, and almost nobody in the latter. Asset allocation is the only factor affecting your investments you can actually influence." William Bernstein, the Intelligent Asset Allocator

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Re: Wiki comments requested: The importance of asset allocat

Post by Taylor Larimore » Thu Jan 29, 2015 9:34 pm

LadyGeek:

This quote may help:

"The first step in assembling an investment portfolio is to decide how to spread your dollars among stock, bond, and cash investments. Spend a lot of time on this decision--it is the most important one you will make."
Straight Talk on Investing by Jack Brennan, Vanguard former CEO
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Re: Wiki comments requested: The importance of asset allocat

Post by LadyGeek » Thu Jan 29, 2015 9:46 pm

^^^ Yes, it does. Taylor Larimore has more quotes in: What Experts Say About "Asset-Allocation & Diversification"

For a new investor, I would think that easy-to-understand phrases (not too "technical") that make a strong point work best. Doing this in one or two sentences should be optimal.

New investors - Does anything of what we've posted so far work for you? Is it understandable and does it bring the point home?

We can argue on the details all day (which paper, what the statistics mean), but the bottom line is we want to educate new investors. Asset allocation is important first, then pick the funds.
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Re: Wiki comments requested: The importance of asset allocat

Post by richard » Thu Jan 29, 2015 9:51 pm

LadyGeek wrote:There are no restrictions on the choices, as we're questioning both versions.

I read your paper* and did the google search. You're right, there is a lot to say on the subject. Your paper has one result, Setting the Record Straight on Asset Allocation (in my first post) says 90% is due to asset allocation.

richard wrote:"Asset allocation is one of the most important decisions that investors can make. We recommend that investors first decide on an asset allocation, then implement that allocation with carefully chosen funds or securities."

How would the first sentence be verified (which sources to use, perhaps Sharpe)? The second sentence "We recommend..." is a forum consensus.

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The degree to which asset allocation is important is a controversial statement. As far as I can tell, the Brinson paper is the original source of the number and it has caused a fair amount of controversy, prompting many defenders and critics, almost none of whom replicate his number. I don't believe we can or will resolve the controversy. BTW, the paper I linked was the first hit I got on the google search I suggested.

"One of the most important" sidesteps the controversy, because it doesn't assign a degree or ranking. I haven't seen any sources that don't put it in the top two or three. If you want a source, Sharpe is fine - he's widely know, Nobel prize, major figure, etc.

Is there anyone here who doesn't recommend first deciding on an asset allocation?
Last edited by richard on Thu Jan 29, 2015 9:55 pm, edited 2 times in total.

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Re: Wiki comments requested: The importance of asset allocat

Post by Random Musings » Thu Jan 29, 2015 9:52 pm

https://advisors.vanguard.com/iwe/pdf/S ... rtPerf.pdf

Seems to have a variety of different sources in paper. Illustrates how active/passive portfolio management can affect the percentage.

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Re: Wiki comments requested: The importance of asset allocat

Post by LadyGeek » Thu Jan 29, 2015 9:55 pm

The link works for me: Sources of Portfolio Performance: The Enduring Importance of Asset Allocation, The Vanguard Group, July 2003.
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Re: Wiki comments requested: The importance of asset allocat

Post by richard » Thu Jan 29, 2015 9:59 pm

Here's a summary of some takes on Brinson, et al, including an Ibottson paper captioned "Does Asset Allocation Policy Explain 40%, 90%, or 100% of Performance?"

http://aatheory.blogspot.com/2007/02/as ... ebate.html

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Re: Wiki comments requested: The importance of asset allocat

Post by peppers » Thu Jan 29, 2015 10:03 pm

Does Asset Allocation Policy Explain 40 90 or 100 Percent Of Performance?

https://corporate.morningstar.com/ib/do ... xplain.pdf
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Re: Wiki comments requested: The importance of asset allocat

Post by livesoft » Thu Jan 29, 2015 10:04 pm

I remember when journalists and the lay-media got a hold of the study. The first thing journalists did was drop the word "variability", then their version got repeated over and over in marketing material, so that asset allocation got correlated with performance and not with the standard deviation of performance. But you all have hashed this out.

If you want to show asset allocation correlated with performance (and not variability of performance), look no further than target retirement funds since their inception. If you want to put a number like 90% or 40% on it, then good luck with that. If you do that, what is the missing percentage attributed to: Market timing I suppose. Oh, and fees+expenses as well.
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Re: Wiki comments requested: The importance of asset allocat

Post by clip651 » Thu Jan 29, 2015 10:08 pm

For a new investor, the sources should be footnotes, or otherwise down the page from the main points that are being made. I wouldn't know whether or not to put a lot of value on a quote by Sharpe, Bernstein, or anyone else until I'd done a few months of reading at least. Make the important points simple and clear. Make the sources, justifications, and subtleties findable, but not in the way of comprehension of the points on the very first read. Some new investors will be college educated, others may still be in high school. Give them all access to the simplicity and important points, and let them seek the details if and when they want them.

Just 2 cents from a newbie that is very, very grateful for this site and the information shared here.

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Re: Wiki comments requested: The importance of asset allocat

Post by richard » Thu Jan 29, 2015 10:08 pm

richard wrote:Here's a summary of some takes on Brinson, et al, including an Ibottson paper captioned "Does Asset Allocation Policy Explain 40%, 90%, or 100% of Performance?"

http://aatheory.blogspot.com/2007/02/as ... ebate.html

I just noticed the author of that summary.

In any event, why use a controversial statement if it's not necessary?

I agree with clip651 about not cluttering the main text with sources. Keep it simple and readable.

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Re: Wiki comments requested: The importance of asset allocat

Post by Peculiar_Investor » Thu Jan 29, 2015 10:12 pm

The finiki article addresses some of these points using the Further reading section which links in a number of the major papers on the subject.

The challenge is how to boil all of this down into a meaningful introduction to the topic that is supported by verifiable sources. One key distinction between forum discussions and wiki articles is the degree to which they require verifiable sources, particularly for important statements such as this.

Disclosure: I'm one of the wiki editors on both sites and part of the "point of contention between several wiki editors".
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Re: Wiki comments requested: The importance of asset allocat

Post by Peculiar_Investor » Thu Jan 29, 2015 10:16 pm

clip651 wrote:For a new investor, the sources should be footnotes, or otherwise down the page from the main points that are being made.

That is how wiki articles are structured. For the purposes of asking the original question, layout and formatting has been modified to fit the forum posting style.

For those that want to see things in their proper context, see Asset allocation - finiki, the Canadian financial wiki.
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Re: Wiki comments requested: The importance of asset allocat

Post by LadyGeek » Thu Jan 29, 2015 10:34 pm

Peculiar_Investor wrote:Disclosure: I'm one of the wiki editors on both sites and part of the "point of contention between several wiki editors".

Disclosure: I'm also one of the wiki editors on both sites and part of the "point of contention between several wiki editors".
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Re: Wiki comments requested: The importance of asset allocat

Post by Leeraar » Thu Jan 29, 2015 10:43 pm

Since I disagree, I'll throw a hand grenade. AA is not that important, within reason.

Asset allocation is an important decision investors should make. Usually, AA is a choice of %stocks/%bonds/%cash. The cash is needed as a short-term buffer. The split between stocks and bonds is a trade-off: Higher allocations to stocks (vs. bonds) have higher expected returns, but also higher volatility, or risk.

(Display efficient frontier curve to show that somewhere from 20% to 80% stocks is advisable for almost anyone.)

AA should be set within reasonable limits, and maintained. But, the fact is that savings rate is by far the most important factor in determining your investment success. AA should not be seen as something to be changed in the short term. Many advisors though, do advocate a "glide path" where younger investors start with a higher allocation to stocks and decrease that over time.

I do not understand the obsession with AA. Decide how much cash you want, and then allocate the rest somewhere between 60/40 and 80/20 stocks/bonds. It doesn't much matter.

After that you can get into a discussion of which kinds of stocks and which kinds of bonds.

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Re: Wiki comments requested: The importance of asset allocat

Post by FrugalInvestor » Thu Jan 29, 2015 10:45 pm

Deleted. Noticed it was a redundant post.
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Re: Wiki comments requested: The importance of asset allocat

Post by LadyGeek » Thu Jan 29, 2015 10:50 pm

Leeraar wrote:Since I disagree, I'll throw a hand grenade.

...But, the fact is that savings rate is by far the most important factor in determining your investment success.

I totally agree. The highest return portfolio you can create still equals zero if you don't start investing.

0.00 return = 0.00 invested * (pick any rate of return, compounded over time)

The sooner the better, see: Re: Save more tomorrow plan - how does it NOT work?
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Re: Wiki comments requested: The importance of asset allocat

Post by peppers » Thu Jan 29, 2015 10:58 pm

peppers wrote:Does Asset Allocation Policy Explain 40 90 or 100 Percent Of Performance?

https://corporate.morningstar.com/ib/do ... xplain.pdf


Upon further reflection, I believe Mr. Brennan's statement cuts to the chase.

Short and sweet.
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Re: Wiki comments requested: The importance of asset allocat

Post by LadyGeek » Thu Jan 29, 2015 11:01 pm

^^^ That would be the suggestion by Taylor Larimore, previously posted:
Taylor Larimore wrote:LadyGeek:

This quote may help:

"The first step in assembling an investment portfolio is to decide how to spread your dollars among stock, bond, and cash investments. Spend a lot of time on this decision--it is the most important one you will make."
Straight Talk on Investing by Jack Brennan, Vanguard former CEO

I'll wait for more comments, but I'm tending to agree.

Leeraar also makes a good point. No investing, no money to reach your goal.
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Re: Wiki comments requested: The importance of asset allocat

Post by staythecourse » Thu Jan 29, 2015 11:01 pm

I will admit I have never read the wiki pages.

I will say if you are going to quote something on asset allocation role I think you have to quote BHB and BSB studies as the are the LANDMARK papers written on the role of portfolio policy role vs. active management (security selection and market timing).

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Re: Wiki comments requested: The importance of asset allocat

Post by clip651 » Thu Jan 29, 2015 11:07 pm

Peculiar_Investor wrote:
clip651 wrote:For a new investor, the sources should be footnotes, or otherwise down the page from the main points that are being made.

That is how wiki articles are structured. For the purposes of asking the original question, layout and formatting has been modified to fit the forum posting style.

For those that want to see things in their proper context, see Asset allocation - finiki, the Canadian financial wiki.


Well, one of the differences between example 1 and example 2 in the first post of this thread is that example 2 contains a direct quote from William Sharpe. If I don't know who Sharpe is yet, that's just a distraction for me. I've been around just long enough to have a vague clue who he is, and it's still a distraction for me. It hits me the same way at the top of the Canadian wiki. And I have more than a few years of post-secondary education behind me, which will not be true of all new investors. So that's where my comment is coming from, FWIW (which I fully realize may not be much). :wink:

I'm not far enough along to have a firm opinion on exactly how important AA is. For me, it's mostly about picking a place where I'm comfortable with the amount of risk, and that I've spent enough time thinking about it to feel like I have a clue what kind of risks I would be taking with various AAs. Nice to know how much it might or might not effect the short and long term portfolio outcomes, though.

cj

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Re: Wiki comments requested: The importance of asset allocat

Post by Tamales » Thu Jan 29, 2015 11:47 pm

My view would either be to avoid "most important," or to state it as the contentious issue that it is, and try to give equal treatment to both sides.
Maybe something like...while there is consensus that asset allocation has some impact on portfolio results, experts differ in quantifying the impact. Some say it accounts for 90+% of the difference in portfolio returns, while others say the effect is less significant than that, perhaps around 30%.

It doesn't become "more right" just because one can gather more supporting views from one side of the argument. A "diversified view" of AA seems like the right approach ;o)

If you have Jim Otar's pdf book, see pg 51 (Chapter 4, "The Importance of Asset Allocation") for his casting of doubt on the experts and their view of asset allocation, and numerous examples of differing AA results throughout the book.

Here is a snip from the conclusions of chapter 4:

"I am not saying asset allocation is not important. In some unlucky cases, maintaining the optimum asset mix might add up to four years to portfolio life at reasonable withdrawal rates compared to holding 100% equity. It also gives to the investor the essential “staying power”. But its contribution is nowhere near 94%. On the average (if I may use that term), it is no more than 30%. Please, don’t make a mountain out of a molehill.

During the accumulation stage, the most important thing is the “Volatility of Returns”. Asset allocation can manage the volatility of returns reasonably well.
On the other hand, during the distribution stage, the most important thing is the “Sequence of Returns”. Asset allocation does not manage well the bad effects of sequence of returns. Therefore, it has little impact on portfolio longevity except in borderline cases."

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Re: Wiki comments requested: The importance of asset allocat

Post by Fallible » Fri Jan 30, 2015 12:12 am

LadyGeek wrote:^^^ Yes, it does. Taylor Larimore has more quotes in: What Experts Say About "Asset-Allocation & Diversification"

For a new investor, I would think that easy-to-understand phrases (not too "technical") that make a strong point work best. Doing this in one or two sentences should be optimal.

New investors - Does anything of what we've posted so far work for you? Is it understandable and does it bring the point home?

We can argue on the details all day (which paper, what the statistics mean), but the bottom line is we want to educate new investors. Asset allocation is important first, then pick the funds.


LadyGeek (and Taylor):

This is correct mainly because it acknowledges who we are writing for. The reader is everything. If we don't get the message across up front, we'll lose them. It's really that simple. Some may struggle for awhile, then give up. There are too many other sources for them to turn to.

To again show the power of simplicity in writing, check out the lead sentence in the "Asset Allocation" chapter of The Bogleheads' Guide to Investing: "Your most important portfolio decision can be summed up in just two words: asset allocation." (Page 89.) The quote above it by Jack could follow. Just a suggestion.

Edit to add that I also like Rick Ferri's reference to AA as "the key element of investment planning." It's from his book, "All About Asset Allocation."

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Last edited by Fallible on Fri Jan 30, 2015 5:52 pm, edited 1 time in total.
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Re: Wiki comments requested: The importance of asset allocat

Post by Christine_NM » Fri Jan 30, 2015 12:31 am

I like the plain, no-quote version. We think AA is important, not because a Nobel laureate said so once, but by the evidence of our experience. And we vary as our experience varies. Most important, the no-quote version plants the seed of doubt about stock picking, technical analysis, and financial porn.

As for the Sharpe quote, 1992 is the middle ages for newbies. The undergrad class of 2013 was mostly born in 1992.

Quoting Sharpe might imply some connection with Financial Engines which BH does not have or want. And next he might reverse himself and say something else is most important. That is the trouble with quoting living people.
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Re: Wiki comments requested: The importance of asset allocat

Post by stlutz » Fri Jan 30, 2015 2:17 am

Many good comments have already been made. To balance that out, let me throw a couple of things in:

Asset allocation is one of the most important decisions that investors can make. In other words, the importance of an investor's selection of individual securities is insignificant compared to the way the investor allocates their assets to stocks, bonds, and cash equivalents.


The first statement is, I think, false. As livesoft points out, if you look at the since inception returns of the TR and Life Strategy funds, it's hard to say that asset allocation is *that* critical. If you look at the various SWR studies that we debate a lot, there is a very broad range of stock/bond mixes that provide very similar success rates. If you look at the "Bogleheads Investment Philosophy" page, the advice it gives on asset allocation is to "never bear too much or too little risk." That's leaves a pretty broad range for what is acceptable.

In many of the portfolio help threads, there is hand-wringing over relatively small differences in asset allocations. I actually think newer investors overrate the importance of asset allocation and spend way to much time agonizing over whether to be 60/40 or 70/30 when things like costs, how much one saves, and whether one engages in adverse market timing make far, far more of a difference.

The second statement is a matter of much controversy on this board. Many people argue that security selection is of critical importance. I'm not sure that we've ever gone more than two days without a new debate over small/value tilting or whatever the latest factor fad is. I've heard the statement that "the value premium is larger than the equity risk premium" too many times to think that there is consensus that security selection is unimportant.

Putting this all together, I started writing up some proposed alternatives, but instead concluded that the box itself should just be eliminated altogether. For new investors, the "Never Bear Too much or too little risk" section on the philosophy page best puts asset allocation in its proper context.

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Re: Wiki comments requested: The importance of asset allocat

Post by Leeraar » Fri Jan 30, 2015 4:39 am

stlutz wrote:... things like costs, how much one saves, and whether one engages in adverse market timing make far, far more of a difference.

+1
Please count me in this camp.

I do not think AA is anything like the "most important" decision, and equating AA with returns is the wrong emphasis. AA is about risk (volatility) and diversification:

Image

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Re: Wiki comments requested: The importance of asset allocat

Post by kksmom » Fri Jan 30, 2015 5:22 am

As someone who considers myself as not an expert, the below reflect my thoughts/understanding of investing.

> Savings/Expenses is more important than asset allocation, particularly for a newbie/accumulation phase.

> Always keep an emergency fund available, based on your life situation.

> Knowing your goal/number: the portfolio size one needs prior to retirement, to meets ones needs based on a safe SWR
I.e. estimated annual expenses and the SWR.

> Reduce expenses: fees/taxes in considering ones portfolio.

> Know ones risk tolerance.

Consider ones chances of losing ?60% (recent recession) or ?90% ( Great depression)of ones portfolio.
Based on ones risk tolerance based on above, choose an asset allocation and stick to it. ?From data , I seem to remember I have read, portfolios with equity 35-65% ,the returns didn’t vary much

> Diversify.
Across assets, across tax advantaged/deferred/free accounts.
One can’t guess the future including future government laws.

>Pundits are not always right. Most of the time everything, is an estimate/guess, based on the past history/current economic reality and the uncertainty of the future.
See the changes in various experts views, regarding social security as a bond, SWR, International allocation etc etc.

> Don’t mix investing with insurance. But along with investing make sure one is adequately insured – life, health, disability etc. Also emergency funds.
Be prepared, for what life happens.

> Market timing may /may not work for people as someone as smart as Warren buffet etc. But I am not as smart/knowledgeable as them, in this aspect of life. I accept that fact, and accept what the market may offer me.

Try to keep life/things simple as Jack/Taylor states.

As WCI states, (if you can/wish to); marry once and stay married. One’s life partner has more effect on ones finances, than your asset allocation.

So, in brief I am not sure asset allocation is the most important decision an investor can make.

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Re: Wiki comments requested: The importance of asset allocat

Post by richard » Fri Jan 30, 2015 6:40 am

LadyGeek wrote:^^^ That would be the suggestion by Taylor Larimore, previously posted:
Taylor Larimore wrote:LadyGeek:

This quote may help:

"The first step in assembling an investment portfolio is to decide how to spread your dollars among stock, bond, and cash investments. Spend a lot of time on this decision--it is the most important one you will make."
Straight Talk on Investing by Jack Brennan, Vanguard former CEO

I'll wait for more comments, but I'm tending to agree.

Leeraar also makes a good point. No investing, no money to reach your goal.

If you're going with that quote, I'd eliminate or rewrite the last clause (--it is the most important one you will make), given that it's both controversial and unnecessary. It appears that it would be more friendly for new investors to eliminate the source or move it to the bottom of the page.

However, there are many good arguments for not going with that quote.

If we're talking overall order of importance, savings rate comes before allocation. kksmom lists some other important things.

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Re: Wiki comments requested: The importance of asset allocat

Post by richard » Fri Jan 30, 2015 7:31 am

Another approach to asset allocation, suggested by sscritic, is to set a contribution allocation rather than an asset allocation. For example, set up periodic contributions at 50/50 and go on autopilot.

This is a reasonable approach and likely followed by a very large number. Employer plans tend to provide that employees can set up the allocation of each contribution. Whether to reallocate or rebalance is regarded my many as tinkering.

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Re: Wiki comments requested: The importance of asset allocat

Post by BigJohn » Fri Jan 30, 2015 8:03 am

I personally like the second one as I think the work "insignificant" is tough to defend in the first one. While I agree that in the context of choosing an AA using a simple 3-fund approach this is likely correct, I'm not sure the same can be said if someone was way out there on their investment choices (eg hedge funds, margin accounts, etc).

While not quantitative, for a new investor I really like how William Bernstein sums up this decision in "If You Can". Does not say it's the most important, just that it's the first decision you have to make.
If I had to summarize finance in one sentence, it would go something like this: if you want high returns, you're going to occasionally have to endure ferocious losses with equanimity, and if you want safety, you're going to have to endure low returns. At the end of the investing day, only two kinds of assets exist: risky ones (high returns and high risks, namely stocks), and what are know in finance as "riskless" ones (low returns and low risks, like T-bills, CDs and money market funds). Job one for the investor is to figure out the appropriate mix of the two.

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Re: Wiki comments requested: The importance of asset allocat

Post by JamesSFO » Fri Jan 30, 2015 8:26 am

BigJohn wrote:I personally like the second one as I think the work "insignificant" is tough to defend in the first one. While I agree that in the context of choosing an AA using a simple 3-fund approach this is likely correct, I'm not sure the same can be said if someone was way out there on their investment choices (eg hedge funds, margin accounts, etc).

While not quantitative, for a new investor I really like how William Bernstein sums up this decision in "If You Can". Does not say it's the most important, just that it's the first decision you have to make.
If I had to summarize finance in one sentence, it would go something like this: if you want high returns, you're going to occasionally have to endure ferocious losses with equanimity, and if you want safety, you're going to have to endure low returns. At the end of the investing day, only two kinds of assets exist: risky ones (high returns and high risks, namely stocks), and what are know in finance as "riskless" ones (low returns and low risks, like T-bills, CDs and money market funds). Job one for the investor is to figure out the appropriate mix of the two.


I really like this quite a lot.

As for the wiki, there are lots of important things that have been pointed out (savings rate, costs, staying the course, etc.) and maybe that's what makes the opener to the article hard.

I believe the open is in response to an unstated assumption many people likely come to thinking that picking the right stock or the right mutual fund (or ETF) is the key to success. In this context, the Wiki quote (and the above from Bernstein) truly is accurate: picking an asset allocation is way more important. Perhaps it would be useful to reset that context for the quote and thus eliminate the issues about savings rate, costs, staying the course, and focus on the sequencing concept.

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Re: Wiki comments requested: The importance of asset allocat

Post by pkcrafter » Fri Jan 30, 2015 9:25 am

I like Fallible's approach. Keep it simple and direct. First, is asset allocation important? Yes. How important? Well, it determines most of the risk you take. I don't think you can, or should, try to get any more precise that that. You can add quotes below if you wish, but any attempt to further clarify will likely end up like this thread.

Bernstein's explanation is pretty clear.

SEC definition--

Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a very personal one. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk.


http://www.sec.gov/investor/pubs/assetallocation.htm

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Re: Wiki comments requested: The importance of asset allocat

Post by tadamsmar » Fri Jan 30, 2015 9:37 am

Asset allocation is one of the most important decisions that investors can make. William F. Sharpe writes "It is widely agreed that asset allocation accounts for a large part of the variability in the return on a typical investor's portfolio."


This is basically a non sequitur. So you are getting to a citation via a non sequitur. Not a good move.

The proportion of variability does not determine the importance of a decision. How much control does one actually have over variability by virtue of some decision making process?

Aspects of asset allocation like diversification are important. And the risk/return trade-off is somewhat predictable so that can be an important decision (at least at the extremes).

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Re: Wiki comments requested: The importance of asset allocat

Post by longinvest » Fri Jan 30, 2015 9:48 am

Here'sa copy of my take on this subject posted on the FWF forum:

http://www.financialwisdomforum.org/for ... 58#p544558

I personally think that many authors and financial advisors put way too much emphasis on asset allocation (AA), so much that a new investor who has no idea of what AA to select will possibly freeze and either not invest or seek co$tly help to select it.

In reality, I think that one should simply pick any AA between 75/25 (aggressive) and 25/75 (conservative)* based on personal taste for volatility, and avoid being too greedy (e.g. not select a more volatile portfolio than one can hold and rebalance during trying periods). Selecting a good savings rate (at least 10% to 15% of income for a young investor) is much more important than the selected AA, specially in early years when contributions dwarf portfolio returns!

Benjamin Graham wrote:*We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequence inverse range of 75% to 25% in bonds. There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums.


In the grand scheme of things, there isn't much difference in returns between balanced portfolios over long term periods. Of course, over very long periods, more stocks usually yield more returns, but not that much more; maybe an average of 1% to 2% more per year (such as 10% instead of 8%), for a 75/25 over a 25/75 portfolio in lucky long time periods for stocks, but at the cost of heart-breaking volatility for some investors. It is easy enough, in general, to save and invest an additional 1% of portfolio during the accumulation stage and still reach one's financial goal with a more conservative portfolio. What is important is to be invested as early as possible to harvest these returns which are way higher, even for conservative portfolios, than that of cash sitting in a savings or checking account (or being spent on consumer junk)!

I think that, otherwise, the only important part of AA is sticking to it, which means rebalancing the portfolio by sending new money into the lagging asset and/or by selling some of the winning asset. When you think about it, this discipline is probably the only logical recipe for managing a balanced portfolio without timing the market.

I know that I am not helping by not providing references for each of my statements. They're the result of my learning from reading the wisdom of some FWFers and Bogleheads (notably Taylor Larimore, nisiprius, and many others). I have not read any book that contains as much wisdom as these two forums.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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Re: Wiki comments requested: The importance of asset allocat

Post by thx1138 » Fri Jan 30, 2015 11:03 am

OK, we seem to have a forest for the trees kind of problem here. Context and scope is vital.

In the context of financial planning decisions and actions I would say AA is very low on the list of importance. Many people have already made excellent points to that effect. Savings rate, spending rate and avoiding behavioral errors are vastly more important than AA.

Second consider that as far as portfolio outcome, by which we mean do we run out of money before death, again AA is not very important at all. By the time you get to sensible portfolio failure rates of less than 5% failure the impact of AA ranging from 25/75 all the way to 75/25 is negligible. How can AA be the most important thing if it has no impact on the results?

So - in the grand scheme of things AA is not very important at all and we should prevent new investors from falling into the paralysis by analysis trap of selecting an optimal AA when in truth there is no such thing as an optimal AA since the results are relatively invariant to AA.

Now then, in a narrower context and in fact in a context that is very important to the whole Boglehead concept AA is more important than any other investing choice when it comes to expected return and volatility. This is the whole point of FF - it turns out that security selection has very little impact on what your return and volatility are, what maters is your exposure to various factors. People can fight over how many factors, but even if you just leave yourself at CAPM the point is your equity allocation is far more important than which equities you choose. And this is the crux of the Boglehead argument - don't go pay someone to choose things that don't matter, i.e. individual securities, instead just buy a big bundle of securities and concentrate instead on how much equity you want.

But the above only matters in the narrow scope of what to do with the money you have to invest, and in that respect AA is far more important than security selection. But it still really isn't directly that important at all, it just happens to be less unimportant than security selection. Really the biggest role AA plays is in protecting an investor in control of their own portfolio from making very costly behavioral errors.

So in summary, I'm a bit concerned about obsessing about the wording of the wiki here because it seems like it is glossing over the much more important context of what things matter. All the references you are looking for merely say AA is more important than security selection. That's true and a fine thing to point out. But the reality is AA hardly matters either compared to all the other things an investor/saver has control over.

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Re: Wiki comments requested: The importance of asset allocat

Post by scone » Fri Jan 30, 2015 11:19 am

I'm not sure the Sharpe reference will resonate much with newbies, he's not that famous. I think you could make the point better with a more homely quote from common sayings and proverbs, something like "don't put all your eggs in one basket."

I do think the language needs to be cleaned up, it's wordy-- cluttered. As Strunk and White say, "Omit Needless Words!"

So here's a shorter, simpler, crisper version:

"Asset allocation is one of the more important decisions investors make. Selection of individual securities is less significant than the overall allocation to stocks, bonds, and cash."

When you shorten the sentence this way, it clearly raises the question that ought to be covered immediately after: why is AA so important?
"My bond allocation is the amount of money that I cannot afford to lose." -- Taylor Larimore

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Re: Wiki comments requested: The importance of asset allocat

Post by Leeraar » Fri Jan 30, 2015 11:23 am

I think the Wiki should not present decisions as sequential and then in order of importance. Rather, it should describe a number of decisions that will contribute to a coherent framework for a plan.

Jim Dahle gets it mostly right:

http://www.hcplive.com/physicians-money ... Retirement

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Re: Wiki comments requested: The importance of asset allocat

Post by Peculiar_Investor » Fri Jan 30, 2015 11:26 am

scone wrote:So here's a shorter, simpler, crisper version:

"Asset allocation is one of the more important decisions investors make. Selection of individual securities is less significant than the overall allocation to stocks, bonds, and cash."

Ok, but from the second part of LadyGeek's original query, can you support this with a citation from a reliable source? That's at the source of the
LadyGeek wrote:point of contention between several wiki editors, as we want to make sure it is both clear and verifiable
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Re: Wiki comments requested: The importance of asset allocat

Post by scone » Fri Jan 30, 2015 11:39 am

Peculiar_Investor wrote:
scone wrote:So here's a shorter, simpler, crisper version:

"Asset allocation is one of the more important decisions investors make. Selection of individual securities is less significant than the overall allocation to stocks, bonds, and cash."

Ok, but from the second part of LadyGeek's original query, can you support this with a citation from a reliable source? That's at the source of the
LadyGeek wrote:point of contention between several wiki editors, as we want to make sure it is both clear and verifiable


I can't do that, because I don't know their criteria for a "reliable source." And since the wiki authors can't agree either, it doesn't make sense to try right now. Since the authors are the deciders, and we Bogleheads are mere stakeholders, they need to agree on their reliability "specifications" before worthwhile suggestions can be made.

It's just like any other form of technical writing in that respect. Well, perhaps not quite that bad... :)
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Re: Wiki comments requested: The importance of asset allocat

Post by richard » Fri Jan 30, 2015 11:41 am

tadamsmar wrote:
Asset allocation is one of the most important decisions that investors can make. William F. Sharpe writes "It is widely agreed that asset allocation accounts for a large part of the variability in the return on a typical investor's portfolio."


This is basically a non sequitur. So you are getting to a citation via a non sequitur. Not a good move.

The proportion of variability does not determine the importance of a decision. How much control does one actually have over variability by virtue of some decision making process?

Aspects of asset allocation like diversification are important. And the risk/return trade-off is somewhat predictable so that can be an important decision (at least at the extremes).

By variability Sharpe appears to mean the difference between the returns of different portfolios, not the variability of the returns of any given portfolio. I will agree with those who say citing Sharpe in the text isn't very useful for new investors.

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Re: Wiki comments requested: The importance of asset allocat

Post by richard » Fri Jan 30, 2015 11:45 am

Peculiar_Investor wrote:
scone wrote:So here's a shorter, simpler, crisper version:

"Asset allocation is one of the more important decisions investors make. Selection of individual securities is less significant than the overall allocation to stocks, bonds, and cash."

Ok, but from the second part of LadyGeek's original query, can you support this with a citation from a reliable source? That's at the source of the
LadyGeek wrote:point of contention between several wiki editors, as we want to make sure it is both clear and verifiable

This is why I continue to believe that ranking asset allocation over security selection is a mistake. There are many sources and interpretations on both sides. In addition, I don't see any good reason for characterizing asset allocation as more important than security selection rather than as something that's important (or very important).

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Re: Wiki comments requested: The importance of asset allocat

Post by Fallible » Fri Jan 30, 2015 11:47 am

Peculiar_Investor wrote:
scone wrote:So here's a shorter, simpler, crisper version:

"Asset allocation is one of the more important decisions investors make. Selection of individual securities is less significant than the overall allocation to stocks, bonds, and cash."

Ok, but from the second part of LadyGeek's original query, can you support this with a citation from a reliable source? That's at the source of the
LadyGeek wrote:point of contention between several wiki editors, as we want to make sure it is both clear and verifiable


The sentence has the needed clarity but I agree the verifiability may be questionable.
Last edited by Fallible on Fri Jan 30, 2015 8:05 pm, edited 2 times in total.
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Re: Wiki comments requested: The importance of asset allocat

Post by Peculiar_Investor » Fri Jan 30, 2015 11:54 am

scone wrote:I can't do that, because I don't know their criteria for a "reliable source."

From the wiki, see Citing sources. Generally the wiki follows Wikipedia's policies and guidelines, unless otherwise specified. On the particular point, Wikipedia:Verifiability - Wikipedia, the free encyclopedia is the general guideline that is followed by wiki editors.

FWIW, the origin of the statement is likely INVESTOPEDIA EXPLAINS "ASSET ALLOCATION", but once again there is no citation to support their statements.
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Re: Wiki comments requested: The importance of asset allocat

Post by JamesSFO » Fri Jan 30, 2015 12:10 pm

Peculiar_Investor wrote:
scone wrote:I can't do that, because I don't know their criteria for a "reliable source."

From the wiki, see Citing sources. Generally the wiki follows Wikipedia's policies and guidelines, unless otherwise specified. On the particular point, Wikipedia:Verifiability - Wikipedia, the free encyclopedia is the general guideline that is followed by wiki editors.

FWIW, the origin of the statement is likely INVESTOPEDIA EXPLAINS "ASSET ALLOCATION", but once again there is no citation to support their statements.


There is a Vanguard research paper to the same effect (as the most important thing) and that was based on their portfolio simulations.

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Re: Wiki comments requested: The importance of asset allocat

Post by Peculiar_Investor » Fri Jan 30, 2015 12:20 pm

As to be expected from the Bogleheads, there is lots of good advice and information being provided and that helps the wiki editors as we work this issue. Thank you.
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Re: Wiki comments requested: The importance of asset allocat

Post by scone » Fri Jan 30, 2015 12:41 pm

I get that there is a policy in place, but if there is "contention" about the interpretation of that policy, as the OP suggests, then I will bow out, until the fighting is over and the all-clear is blown. I mean, check this out:

"The content of the notice has become a point of contention between several wiki editors, as we want to make sure it is both clear and verifiable. So far, we haven't been able to come to an agreement, so I'm throwing this out to the general forum for opinions."

Making the entry "clear" is basically a language issue, which is difficult, but making it "verifiable" is even more difficult. In this case, it's not so much about claiming some kind of absolute truth-value, as it is about decorating the statement with the glamour of appeal to authority. You see the problem? My favorite "expert," from whom I would want to take a citation, might be your most hated enemy. You can quote an authority, but if the other guy gives you the raspberry, you aren't helping to make your case.

And so the long day wears on. Perhaps I've endured too many software development policy meetings. :shock:
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