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Contrarian view on asset allocation

A question has just been posted on TMF that has been going through my mind recently.

Everyone knows that asset allocation is important, and that a balanced portfolio is essential, but is it?

If you are investing for the long haul (say retirement in 20 years or longer) why should you not have 100% of your investments as equities?
We know that equities are the best performing class of investment over such a time frame, so why do we want to dilute the total return on our portfolio by having some bonds or fixed interest?

The only reasons I can think of are that equities may see a long term downturn (more than 20 years) - but how likely is that given the fact that it has never happened, and if it does surely it has much wider implications on society anyway?
And the other reason is that investors couldn't take the psychological damage of seeing their investment portfolio showing a loss for perhaps 3-5 years in a row, and thus the sacrifice of giving up some return is matched by being able to sleep at night during your 20 year investment life - even though they are giving away some of their value for the privilige.

So can some of the experienced posters on here tell me why having a balanced portfolio is so important?
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Comments

  • dunstonh
    dunstonh Posts: 120,181 Forumite
    Part of the Furniture 10,000 Posts Name Dropper Combo Breaker
    If you are investing for the long haul (say retirement in 20 years or longer) why should you not have 100% of your investments as equities?

    RISK RISK RISK.

    You build a portfolio to suit YOUR attitude to risk. If you can accept the volaility that goes with 100% equity exposure then that is your choice.
    We know that equities are the best performing class of investment over such a time frame, so why do we want to dilute the total return on our portfolio by having some bonds or fixed interest?

    In addition to RISK if you rebalance your portfolios annually you use the lower risk funds to counter performance. For example, if you have 10 funds and put 10% in each (which you wouldnt but it keeps the example simple) over the years the funds would have different performances. In 2001, the equity funds would have lost 40% but in 2003-6 they would have had the growth. So, if you had annual rebalancing, in the years before the crash money would have been coming out of the equity funds into the low risk. After the crash, the money would be coming out of the low risk funds into the higher risk funds. So you are taking out profits when high and reinvesting when low.

    The other thing to note is that asset allocation doesnt just mean equities vs property vs fixed interest etc. It means Japan, Far east, European, Global specialist, UK, North American etc. At various points, each sector will have different performance. US has made hardly anything in last 5 years. Japan did around 100% last year. Latin America year before (and much of last year). FTSE100 hasnt made a thing in 6 years.

    Put all your eggs into one sector and you may get lucky but dont count on it.
    So can some of the experienced posters on here tell me why having a balanced portfolio is so important?

    Key things then are risk and equities not meaning one thing but a range of investment sectors. A high risk portfolio may not have much or any fixed interest or property but it will still be spread amongst the sectors.

    If you put 100% in the best performing fund of 10 years ago or chose a asset allocated spread of investments which performed only at sector average, your investment in spread would have outperformed that best fund.

    Rebalancing is where the lower risk sectors can really come into play though.
    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
  • Oompa_Lumpa
    Oompa_Lumpa Posts: 111 Forumite
    dunstonh wrote:

    If you put 100% in the best performing fund of 10 years ago or chose a asset allocated spread of investments which performed only at sector average, your investment in spread would have outperformed that best fund.

    Rebalancing is where the lower risk sectors can really come into play though.

    Dunstonh, thanks for once again taking the time to answer (in great detail) my question.

    Could you please expand on your first paragraph that I have quoted, I don't quite follow how an investment spread could beat solely investing in the best performing sector over the same time period?
  • cheerfulcat
    cheerfulcat Posts: 3,406 Forumite
    Part of the Furniture 1,000 Posts Photogenic Name Dropper
    Everyone knows that asset allocation is important, and that a balanced portfolio is essential, but is it?
    Most people haven't even heard of asset allocation! You've been hanging arount the Fool too long :)

    IMO it is not so much the balanced portfolio that is essential, it is the knowledge of how assets interact. There is nothing wrong with a portfolio of 100% equities, or even a portfolio concentrated entirely in one sector, as long as the investor is aware of the risks involved and has made an informed decision to construct a portfolio in this manner. Having said that, most people, and especially those who don't wish to spend time managing their investments, would probably be best off with a broad spread.
  • dunstonh
    dunstonh Posts: 120,181 Forumite
    Part of the Furniture 10,000 Posts Name Dropper Combo Breaker
    Could you please expand on your first paragraph that I have quoted, I don't quite follow how an investment spread could beat solely investing in the best performing sector over the same time period?
    The key thing is the best performing fund at that time (which is most likely the best sector to be in that time). The top performing sector at that time may take another 5-10 years to be top again.

    Each year a different sector takes it in turn to be the best area to invest in. If you pick the UK, you can expect it to be the best performing sector once every 5-7 years (at least historically. Probably less frequent going forward). So, stick all your money in the UK and it will be best once, maybe twice in that 10 years.

    What goes down comes up and what goes up comes down. So, when rebalancing is done with the sector allocations you end up taking money out of the faster growing funds and putting it into the ones that havent grown as much or have gone down. Then when the faster growth funds fall back, you havent lost as much. Then another sector takes over as the place to be and the money you have fed into that picks up.

    Its hard to explain in words. Its easier with charts.

    If you invested in a FTSE all share tracker in 2001 you would have seen a drop of around 40% with the crash. In that same period, a sector allocated portfolio built to the same risk profile with annual rebalancing would have lost less than 20%. That portfolio would have grown by over 15% a year average in that 5 years but the FTSE all share tracker would have grown by 3.8% pa. avearge.

    A side issue there is that all those people smug that they are paying 0.5-1% pa. less because they bought a tracker dont realise that they are nearly 11% a year worse off because of it. Of course its not as simple as that as you can use trackers within a portfolio (and I do) but most using trackers dont do that.
    Most people haven't even heard of asset allocation! You've been hanging arount the Fool too long
    Many advisers haven't either!!! No tied agent will or can do it. Many IFAs are not experienced or qualified enough. Although IFA knowledge is improving all the time on that front. Of course of lot of the reason why its becoming more known is that computers and information is more easily available now. Plus the costs of transactions and the product tax wrappers are cheaper and more flexible.
    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
  • akkd99
    akkd99 Posts: 3 Newbie
    Hi, sorry to jump in on this post but I was wondering how you can apply asset allocation as a (very) small investor.

    Owning a house makes me already heavily exposed to property (and I certainly wouldn't be looking to go for a buy-to-let). I also have a pension which I would assume (but don't actually know for sure) would be mostly in low-risk investments such as bonds and commercial property.

    Given this is there any point with such assets rather than pure equities (of course trying to balance risk with those equities)?

    akkd99
  • Chrismaths
    Chrismaths Posts: 931 Forumite
    You can pay someone else to do it for you via a fund of funds.
    It depends on how much you are investing, because to get a decent spread of investments, for small amounts the transaction costs are too high.
    For me, for average risk, average everything (as if that exists - the average man has less than two legs!), Portfolios > £250,000 have a large direct equity exposure (in the UK) & collectives for overseas, > £100,000 might have some large cap UK equities as well as collectives, £50,000>£100,000 would have individual unit trusts allocated between sectors, £20k>£50k would have funds allocated to broader sectors (like "Global equity" or "Bonds"), then less than this would probably be best in a fund of funds.
    I'm an Investment Manager. Any comments I make on this board should be not be construed as advice, and are for general information purposes only.
  • dunstonh
    dunstonh Posts: 120,181 Forumite
    Part of the Furniture 10,000 Posts Name Dropper Combo Breaker
    I also have a pension which I would assume (but don't actually know for sure) would be mostly in low-risk investments such as bonds and commercial property.

    There is no difference between pensions, ISAs, Unit Trusts/OEICs and investment bonds apart from the taxation, charges and scheme rules. They can all invest in the sames and the same investment rules apply to all of these. The only difference maybe the amount of risk you are willing to take due to differing goals.

    You shouldnt assume anything about your pension. Most people are invested in poor quality pension funds. Most could be switched to a diversified portfolio within 24 hours at no cost.

    Also, do not mix up property as your primary residence with commercial property investment funds. You live in your property. Its usually best not to consider it an investment.
    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
  • cheerfulcat
    cheerfulcat Posts: 3,406 Forumite
    Part of the Furniture 1,000 Posts Photogenic Name Dropper
    Hi there, akkd99,

    I don't myself include my house in my portfolio as I see it as a home, not an asset to be sold. But it is a matter of personal preference.

    It is dangerous to assume things about your pension - best to find out for sure what it is invested in!
    Given this is there any point with such assets rather than pure equities (of course trying to balance risk with those equities)?

    I think that there is at least a point in thinking about the asset allocation, even if you come to the conclusion that you are happy with things the way they are. A carefully thought out portfolio of any sort is likely to do well, assuming that the investor has a reasonably intelligent strategy. Unfortunately many people just have higgledy-piggledy collections of old flavour-of-the-month ISAs randomly bought and tossed into a corner; then they complain about how risky the stock market is, when this ragbag assortment of dogs starts barking...
  • hobbesandco
    hobbesandco Posts: 104 Forumite
    A side issue there is that all those people smug that they are paying 0.5-1% pa. less because they bought a tracker dont realise that they are nearly 11% a year worse off because of it. Of course its not as simple as that as you can use trackers within a portfolio (and I do) but most using trackers dont do that.

    Dunstonh, can you explain why those who bought a tracker are 11% a year worse off because of it? I can't quite follow.

    Thanks.
    :rotfl: :dance: _party_ :grouphug: Laughing all the way...:EasterBun :kisses3:
  • dunstonh
    dunstonh Posts: 120,181 Forumite
    Part of the Furniture 10,000 Posts Name Dropper Combo Breaker
    Dunstonh, can you explain why those who bought a tracker are 11% a year worse off because of it? I can't quite follow.

    Over the last 5 years the FTSE all share tracker would have grown by 3.8% pa. avearge. A sector allocated portfolio with annual rebalancing set to the same risk profile as the FTSE all share tracker would have grown at 15% p.a. average.

    You can include trackers in a portfolio but most of those buying tracker funds do not. So, this is not a tracker vs managed debate but more a single sector investment vs diverse portfolio issue.
    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
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