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Rethinking Traditional Asset Allocation

Posted on 03/23/2015

Rethinking Traditional Asset Allocation
by Walter H. Brown, Investment Council, magii Wealth Managment 

I have been exposed to many different theories on  what is the most efficient way of managing clients’ portfolios in my 20 years in the financial services business.  Among them are indexing, dollar cost averaging, diversification, efficient markets, total return, hedging, asset allocation and many other terms too numerous to mention in this space.

 The strategy I would like to talk about today is the most used and most regulated; asset allocation.  For many years the brokerage firms and their compliance departments have been very focused on the percentage split between equities and bonds in the asset allocation model the first step to developing a portfolio. The standard wisdom and accepted practice is the older you get the more conservative your portfolio should be therefore the bond allocation should increase versus the equity allocation as you age.  The rule of thumb would be to subtract your age from 100 and that’s the percentage that should be allocated to equities. For example, if your age is 65 that would mean your equity exposure should be no more than 35%.

 The thinking behind this theory is as you age you should take less risk so that if the market has a major correction and loses a significant percentage you will not lose as much as the overall market. Because of your age and relationship to retirement you may not have enough time to wait for the inevitable recovery. 

This entire one size fits all thinking, although in most time periods would make sense, to me is not the appropriate strategy for today’s low-interest rate market.

 Currently, due to political and economic concerns the Federal Reserve has artificially kept interest rates historically low for many years. I understand that this was done to stabilize the US economy and revive an imploding housing market, but the simple fact is rates have been kept low for many years.

 Due to the fact that the market has been distorted by the low interest rates, I would submit that one must rethink historical standards as it applies to the traditional asset allocation model.

I wonder, have the computer generated models or the brokerage firms’ compliance departments altered their plan allocations to take this anomaly into account?

 When interest rates start rising, which should happen sooner rather than later, who is going to inform an 80 year old client, who has been earning 2-3% on his overweighed bond portfolio for the last six years, that his portfolio value is about to be cut in half when interest rates return to their historically correct value?

In conclusion, all asset allocations plans must be modified in accordance with current market conditions, regardless of age.  This is an extraordinary time and old historical wisdom does not necessarily apply.

 Unfortunately in many institutions old habits die hard and ultimately it is your money. You must stay in touch with your financial advisor and keep in touch with what they are thinking and how they are reacting to market conditions. Stay informed and have confidence that your portfolios is being managed to meet your long term goals.  

 If you would like a second-opinion, we at magii wealth management are happy to speak with you in regards to any questions that you may have.  

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