Some said it was dead. Others claimed it was misleading. Many simply ignored it, in good times and bad. But asset allocation is hardly dead. In fact, it couldn’t be any more relevant.
The mistake that many investors make is comparing a multi-asset class portfolio to something riskier, such as any one asset class. In fact, there are countless ways to beat a multi-asset class portfolio over the short- as well as long-term horizons. Doing so after adjusting for risk, however, is far more difficult.
It’s easy to find one asset class or one security with an expected return that’s far higher than the market portfolio, which we’re defining as all the world’s major asset classes weighted by the market values. The problem is that there’s something approximating an equal abundance of asset classes and individual securities with lesser prospects at any one time relative to the market portfolio. Distinguishing one from the other isn’t impossible, but it’s devilishly hard to do continually, year after year.
Does that mean we should simply buy and hold the market portfolio? Probably not, although it’s worth pointing out that you could do a lot worse. Consider, for instance, one measure of the market portfolio, as defined by the Global Market Index (GMI), courtesy of The Beta Investment Report. For the 10 years through the end of July 2009, GMI posts a 3.8% annualized total return, which is considerably better than the 1.2% annualized loss for U.S. stocks, as per the S&P 500.
Still, the temptation is always there to do something else. There have been times in the past, and there will be times in the future, when U.S. stocks beat GMI, for instance. That’s true for any of the various stock, bond, real estate and commodities components that collectively comprise GMI. Why not simply own the components with the highest expected returns and shun everything else?