Jan 26, 2011
With the growth of the ETF market, you see increasing amounts of discussion of asset-allocations. While this is a good thing, a few realities need to be addressed more often.
An allocation that has no particular bias to it does not do much good. Yes, it is possible to create a fully-diversified portfolio for very low cost these days. But while having a little exposure to everything might be ok to use as a benchmark, let's not forget that you do actually have to materially bias your portfolio to differentiate it from the benchmark.
Let's look at an example --- I saw a recent article that attempted to use the "wisdom of the market" to tell you how to set your allocation. The methodology took the asset allocations from a number of other sources, averaged them and came up with this:
It looks diversified. It's definitely low-cost. But that is about all you can say about it. Using our (free) Backtest Portfolio Allocations App, I ran the above allocation and here is how it looks for the past two years relative to the S&P 500 index:
As you can see, an allocation that has no bias or particular bets just reverts you back to the same basic overall market exposure. Outperformers and underperformers just offset each other for the most part in this particular portfolio. It is not just that the overall return is the same --- but the chart makes it clear the path from start to end is the same as well. If you didn't run the chart and see this for yourself, you probably would have thought that the allocation was actually doing something it is not.
Summary: The hot topic these days is about asset-allocation --- however, don't necessarily assume that just because it's an 'asset-allocation' that it actually is differentiated in any way, shape or form. Many asset-allocations just ultimately mimic the same basic exposure. It doesn't take much testing or research to determine this -- but it does take a little.
Follow us on Twitter: