I know that I will stir some controversy (which I’ve been known to do in my career) with this chapter, but it’s necessary for me to voice my feelings on the topic of asset allocation because of what I believe is the false sense of security it can convey.
I have nothing against the asset allocation concept, where assorted percentages of one’s investment capital are placed in a variety of different asset classes depending on factors such as age, risk tolerance, investment objectives, and other considerations—thus offering a diversified approach. Asset allocation is easily one of the most spoken phrases in our industry.
A difficulty with investors having a balanced exposure across multiple categories, however, is that while they may be diversified against losing a huge chunk of their total assets in any one sector, they can also be so diversified as to minimize the impact that a meaningful gain in any one of those categories will have on their total assets. The biggest concern, however, is that there are precious few places to hide during a primary bear market, where cash is often your best friend if you don’t happen to be “short” the market (making a downside bet, as discussed earlier).
A primary bear market will often inflict a great deal of damage across a broad spectrum of categories, so that even if you’re invested across a range of investment sectors, the cumulative total of those losses can still be severe. That’s why I wouldn’t take any comfort in the fact that one happens to be “well-diversified” during a bear market. What difference does it make how seemingly well distributed your assets are if you still lose a hefty portion of your capital by remaining invested during a primary market decline? Likewise, just because you own multiple properties in a county or state won’t protect you if there’s a pronounced regional decline in real estate values.
Again, I fully understand the concept behind the approach. I get it: you don’t want to be concentrating your capital too narrowly. The potential risk is simply too great. That’s a reason why mutual funds and exchange-traded funds (ETFs) have grown to the extent they have. But in a primary bear market, cash is better than having a well-diversified equity portfolio, no matter what shape it takes. Bear markets offer little investment cover. It’s like trying to hide a sumo wrestler behind a toothpick.
(To be continued...)
This excerpt is taken from “Relationship Investing: Stock Market Therapy for Your Money” by Jeffrey S. Weiss. To read other articles of this book, click here. To buy this book, click here.
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