There is an old saying, that if you do the little things right, the big things will take care of themselves. And in almost every case, from a football team driving towards a championship season, to a fledgling business trying to gain customers, does this maxim usually prove correct. Then why, one might ask, in the investment world do most professionals focus most of their time on trying to make the big decisions?
Several years ago, there was a bunch of research done that suggested that most folks’ investment returns were primarily determined by which assets or sectors they allocated a percentage of their capital to. And like the light of a match, people started trying to determine what their “optimal asset allocation framework” should be. They posited that maybe it should be 60% stocks and 40% bonds, or 50% towards healthcare companies and 50% towards commodities, or 20% in cash and 80% in real estate, and well you get the idea, this list goes on. The thinking was, that if you get the exact percentage of each asset class right, it wouldn’t matter so much what the individual investments actually are.
And while I’d probably agree that methodology of this research was likely done with solid empirical backing, I’d argue that the conclusions drawn from it were entirely backward. To me, at least, it seems impossible to determine the exact percentage of one’s portfolio that should be invested in a particular asset class, no matter how much data analysis one does. Nor is it feasible to determine in which asset class, in fact, the money should be invested.
The problem was that most folks’ conclusions were that the most important thing to do was to make big top down decisions about how they wanted to invest their money. I’d argue, on the other hand, that this asset allocation research should instead be interpreted as the outcome of continuously searching for reasonably priced individual investments. And if one starts finding good investments (which can tend to cluster in the same assets or sectors), their portfolio will exhibit a certain “asset allocation framework,” but it will be arrived at by finding good investments, rather than drawing a line in the sand and deciding how the assets should be allocated.
The difference in these interpretations is dramatic. One viewpoint (the top down one) compels action. The other, (the outcome one) educates the investor about what her portfolio actually looks like. And to me, at least, education almost always trumps action.
The bigger implication of this “outcome” viewpoint, though, is that the individual investments do matter. There are thousands of stocks and thousands of bonds, and by just saying that you have 60% of one basket and 40% of another, says nothing about the quality of your portfolio. If, on the other hand, one finds good and understandable investments at reasonable prices, that investor will do just fine, regardless how someone else labels their investments. Just like the old saying above implies, by focusing on the individual investments in your portfolio, your larger “asset allocation framework” will eventually take care of itself.
I welcome dialogue with my readers, so please send me any questions and comments you have. Also, if you haven’t already done so, please be sure to sign-up for my free email alerts by emailing me at BuffettInsights@gmail.com.
Justin
Copyright © 2009 BuffettInsights
The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.
