Be an Investor, Not an Asset Allocator

While I  respect the concept of diversification, I also believe that you can become too enamored with Modern Portfolio Theory and statistical backtesting when creating an investment strategy.  This seems to be a common problem among the investing public today, due largely to the way the investment industry has promoted and institutionalized the process.

There was a time, before the advent of mutual funds, when stock brokerage firms were compensated largely by commissions earned from recommendations.  Obviously, some of  the firms and brokers were skilled at analyzing ideas, and many were not. The focus was on research, not investment banking or IPO’s, and the commissions were lucrative enough to support this focus.  Additionally, information didn’t flow as quickly or efficiently, and it was very difficult for the average investor to make good decisions regarding even the most liquid public companies.

With the creation and ensuing popularity of the mutual fund, institutional money management became the default option for most investors.  As time progressed, new and creative ways were developed to take advantage of technological advances as well as to more effectively gather assets.  Beautiful, statistical models were created utilizing the concepts of Modern Portfolio theory which added confidence in allocation models.  Pretty soon, we all became familiar with “style boxes” and the necessity of having assets in many different categories.  We want to smooth and enhance returns.

Index funds were developed to keep costs low and provide strict, style-box returns.  Proponents of index  investing suggested that active money management was pointless since so many managers do not outperform their index over certain periods of time.  It’s easy to buy into this argument, given the historical data that seemingly validates this opinion.

It seems to me, however, that strict adherence to indexes and asset classes provided very little comfort or protection to people during the 2007 collapse and ensuing economic turmoil.  My personal experience and that of our clientele indicates that a focus on tactical considerations and fundamentals has enhanced returns and smoothed volatility.  When we buy mutual funds for our client portfolios, we prefer lower-turnover, focused funds that don’t try to mimic an asset class.  We look for experienced money managers who have longer-term track records (preferably 10 years or more) and who have a unique approach.  In other words, investors with skill.

We also do not shy away from making investments in individual common stocks and ADR’s of companies we plan to buy and hold for longer periods of time.  We diversify, but not to the point of blind belief in a statistical model.  You can do the same thing, and there are many resources available for those with this inclination.  Read LOTS of books. Read everything by Warren Buffett and Charlie Munger.  Value Line and Morningstar are  great resources for research.  The National Association of Investment Clubs provides tools and techniques for evaluation stocks.  Or, you can work with a NAPFA-Registered fee-only advisor who specializes in this type of investing and collaborate on your portfolio.

In other words, commit to being an investor or hire someone who is.

About the author

Doug Kinsey, CFP®

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