If we want to be successful investors, perhaps we should examine just what areas contribute to success or failure, and what areas are subject to our control.
Investors tend to focus more on trying to pick the right investment at the right time than they do on the all-important issue of asset allocation.
Asset Allocation is the mix of investments you own – across cash, fixed interest, property and shares. The mix may be income orientated, growth orientated and so on.
A study in 1986 examined the investment results of 91 very large managed funds to determine how and why their results differed.
Each fund had access to the best research and information. In other words, they certainly had the resources available to "beat the market."
The researchers reasoned that only four elements could contribute to investment results: investment policy (the asset allocation or mix), individual investment selection, market timing, and costs.
The conclusions were surprising. Comparing the funds results to the market returns the researchers were able to explain 93.6 percent of a fund's performance based solely on knowing its asset allocation – the spread over cash, fixed interest, property and shares.
That left less than 6 percent of the difference in results to be attributed to the other three variables including the specific investments chosen.
The other factors did contribute to the differences in total return, but not necessarily in a positive way.
Attempts at market timing almost always resulted in a reduction of return, and individual share selection, rather than buying the market, on average resulted in a reduction to the funds' returns.
The study concluded that on average, attempts to actively manage the portfolios rather than holding the asset allocation mix at the agreed level actually cost the average fund 1.10 percent per year when compared to just buying and holding the appropriate indexes.
Today, this issue is considered reasonably settled. No one disputes the large impact of asset allocation on investment results and the far smaller impact of timing and manager/share selection– except perhaps those who don’t know about it.
We spend some time talking about asset allocation with our clients, the reason being that it is the key decision in determining both the likely return as well as the associated level of risk that will attach to their investments.
