How Should You Customize Your Asset Allocation?

Everyone (or nearly everyone) agrees that investment portfolios should be customized, based on an investor’s risk tolerance, objectives, time horizon, and so on. Where minds differ is deciding how to customize. There are two basic paths. The first, which is the overwhelmingly popular route, is building portfolios from the ground up, security by security, fund by fund. Peter Betenstein called this approach the “interior decorator fallacy” in Capital Ideas. Why? Finance theory recommends using the same mix of risky assets for everyone, adjusting the weight of cash, if any, as the lone variable for customizing portfolios. The 80-year-old holds lots of cash while the 20-year-old has a zero weight in liquid assets, or something along those lines. To the extent that they both own risky assets, their allocations in that realm are the same. Almost no one does this. Is that a mistake… or enlightened thinking? In search of an answer (or at least some perspective), I consider the topic in some detail in “Puzzling Behavior” in the April issue of Financial Advisor magazine.