Tuesday, May 15, 2012

Asset Allocators

You've heard this before: If you ASSUME, you make an A$$ out of U and Me.

How about if you ASSET ALLOCATE, you do something similar to you and your clients.

What? Sacrilege! Asset allocation is tried and true.

Whoa, cupcake, I have a twist for you. I am not against asset allocation. After all, if you moved into bonds and out of stocks in 2008 you did pretty dang well.

But think about what this can do in a steep move - up or down. Let's use the easier to understand - the bear market.

Let's say you reallocate your funds quarterly. Seems reasonable. You want to keep a balance of 60% stocks, 30% bonds and 10% cash. Again, reasonable although not my cup of tea.

Using round numbers, let's say your stocks drop 10% in value. At reallocation time you buy more stocks and trim some of your bonds and cash to get back to that 60-40-10 allocation.  So far, so good, right?

Now let's say stocks drop another 10% and you repeat this process of getting back to 60-40-10.

And then it happens again. This is a bear market. Stocks are going to get cut by 40% in a year - big but not outrageous.

Do you see what has been happening? You've been adding to losing positions and trimming winning positions. Did they teach you that in CFA school?   If the bear lasts long enough, you may have allocated your capital away.

I propose you apply a little technical analysis to the allocation process. Do not reallocate unless the relative values of stocks relative to bonds and cash turns the corner. In other words, when stocks stop falling. Then, by all means, allocate your assume off.

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