Jan 29th, 2008
How Asset Allocation Helps Your Portfolio
Yes, at least for now, the market has been in a downward slant. Through today, the S&P500 is down 7.8 percent for the year, which is nothing to feel great about. On the other hand, my retirement portfolio is down a bit less than that: 6.2 percent.
How has my three fund portfolio managed to outperform the S&P 500 over this very short period of time? One reason and one reason only: asset allocation. The domestic stock fund in my portfolio with more diversification than the S&P 500 is down essentially the same amount, but that’s only about half of my portfolio. The international stock fund that makes up about another fourth of my portfolio is down a steeper 10.75 percent. However, the remaining fourth of my portfolio, the total bond market index, is actually up–a scant 1.6%, but up is better than down. So spreading my assets among several different types of investments helped me outperform the S&P 500–again. If you recall correctly, my retirement portfolio last year also outperformed the S&P 500. There is, of course, no guarantee that this will continue to happen, but this little illustration over a way-too-short period of time helps to illustrate that asset allocation continues to be important in the way your portfolio as a whole performs.
Asset location in itself does not generate alpha (extra returns), so this is not why you are doing better than the sp500. Write it down to luck. The diversification does reduce risk-return which is why it is a good idea.
Hi,
Thanks for participating on the blog. Your comments are appreciated, and I also have some comments.
I acknowledge that I did not state explicitly in this point that the better return to date this year is due to risk reduction rather than seeking higher returns (although my previous post on the importance of asset allocation stressed that risk reduction was the reason to consider how your assets were allocated), so I will state it here: the better return in the portfolio to date is due to risk reduction.
However, I would disagree with this result being the result of luck. Reducing risk, as you state, is “a good idea”, and the fact that asset allocation reduces it and in this case provided a better return isn’t due to luck–it’s due to planning. I only had the assets allocated the way they were because I planned for it, and the fruits of good planning aren’t due to luck.