One of the best ways to start the asset allocation in a portfolio is with a foundation of an asset that will avoid any emotional reaction to the ups and downs of the market. A great way to begin is short-term, high-quality corporate and government bonds.
We know these types of bonds present little credit, inflation or interest rate risk. Including them in a portfolio allows you to take more risk in other asset classes with potentially higher returns.
A Little History
Back in the 1980s, academics Gary P. Brinson, L. Randolph Hood and Gilbert L. Beebower published a study based on the review of 82 large pension funds. They were able to conclude it was asset allocation that was the determinant for more than 94% of the returns among those funds. Interestingly, less than 6% of the returns were actually due to market timing or investment selection. That says quite a bit about stock picking, because if your allocation is correct, you are 15 times more likely to achieve your goals and sleep better at night.
Don’t try to figure out who is the best manager; instead figure out what allocation works with your risk tolerance. It’s actually very easy to find out who the top performers are at any point in time — the tricky part is knowing ahead of time!
Also, it’s very rare that top performers repeat their performance. In fact, one-third of the money managers tend to beat the market every year, but unfortunately it’s different ones each time.
Don’t be fooled. Annual lists of top managers are usually the top performing managers in whatever happened to be hot at the time. These “hot sectors” ultimately cool, and another sector or manager steps in.
Spend your time on asset allocation. It’s been documented and proven to determine your returns. It simply does not make sense to chase what’s hot. What’s really important is what asset class adds to your return and reduces your risk.
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