Hi Guys,
Most of the time the investment marketplace seems to behave like an erratic bouncing ball. Its erratic returns generate fear and uncertainty for the investing public which translates into panic selling at precisely the wrong time.
Mitigating that bouncing ball is a partially doable task by reducing portfolio returns variability. Asset allocation that fully embraces a broad diversification policy is king in executing this goal. None of this is new stuff. Here is a Link to the classic paper that initiated a host of continuing complimentary studies:
http://www.cfapubs.org/doi/pdf/10.2469/faj.v51.n1.1869Two decades later, one of the original researchers updated his interpretation of that study. Here is a Link to that update:
http://www.retailinvestor.org/pdf/Hood20yrsLater.pdfThe paper ends with the following summary advice: “Our message today remains the same as before: Carefully consider what goal you are trying to achieve, how important it is to achieve it, and how much risk you are willing to tolerate in pursuing it. Then, create a policy portfolio that reflects that goal and your risk tolerance for the probable outcomes—because executing that policy will have a dominant effect on your success.”
Independently, a recent Vanguard study further emphasizes the benefits of broad diversification. Vanguard expands the data sets to include foreign marketplaces. Here is a Link to that study:
https://personal.vanguard.com/pdf/s324.pdfFor 4 international marketplaces, Vanguard concludes that “For investors who held broadly diversified portfolios, asset allocation was the primary driver for return variability.”
Although these generic findings are not new stuff, an individual investor’s access to test the robustness of his asset allocation planning and decisions in a user friendly format is indeed new stuff.
Recently I’ve been emphasizing the advantages of Monte Carlo analyses, especially using a version of that tool on the Portfolio Visualizer website. That website also offers a very nice Back-Testing tool that enables investors to easily explore alternate asset allocations on a side-by-side basis, and, for different time periods. Here is a direct Link to that Back-Testing code:
https://www.portfoliovisualizer.com/backtest-asset-class-allocationIn addition to a benchmark comparison option, the referenced code allows for side-by-side comparisons of 3 additional portfolios simultaneously. The stability of various asset allocations over any timeframe is effortlessly tested with the click of a single starting date input. The summary relative outputs as a function of time are useful for decision making.
One disadvantage of the site is that it only has data for the broad categories of investment options. The site does not offer data for specific mutual funds. I believe that is a minor shortcoming. Individual fund performance returns will hover both above and below the category averages. Statistically, any departures will likely cancel each other out.
I suggest you give this Back-Testing program a few trial runs. It’ll provide some guidance when you’re mulling over some portfolio asset allocation changes. Additionally, it’s fun.
Best Regards.
Comments
Thank you for the return post. It's good to know I just might be doing some good. I hope you increase your portfolio's value each year using the asset allocation tool.
There's an old Wall Street saying: " We can't direct the wInd, but we can adjust the sail". Some things are in our control, others are not.
The investment equivalent of the saying is that we can't control market returns, but we can adjust our portfolio's asset allocation to capture much of its benefits.
The studies I referenced claim that the allocation decision accounts for 90 to 95% of portfolio variability. Personally, that seems like a bit much, but the significance of the asset allocation decision is undeniable.
The referenced website should prove to be very helpful.
Good luck and Best Wishes.