FYI: YOU’VE NO DOUBT heard this before: Asset allocation is the single most important investment decision. If you have the right mix of stocks, bonds, cash and maybe real estate, you sharply increase your chances of success.
But how do you pick the right mix? There are rules of thumb based on age, there’s a statistical approach called Modern Portfolio Theory, there are risk tolerance questionnaires and there are cash flow-based approaches. Each delivers a different answer—because each emphasizes different factors.
What if the answers differ dramatically? It’s not uncommon for a strictly mathematical analysis to result in an asset allocation of 100% stocks. Meanwhile, if that same person were to fill out a more qualitative risk questionnaire, the result might be far more conservative.
What should you do if the math says one thing but your stomach says another? Should math trump emotion—or the other way around? As you wrestle with this question, here are five consideration
Regards,
Ted
https://humbledollar.com/2019/06/math-vs-emotion/
Comments
Emotional investment decisions will ruin a portfolio. The numbers are uncertain but reflect history. While history will not exactly repeat itself, it will be as accurate a projection that exists. Go with the numbers. Here is a reference to an article that shares my opinion:
http://awealthofcommonsense.com/2015/11/playing-the-probabilities/
The closing statement tells it all: “Annual returns are all over the place and rarely do investors experience average performance in any given year as you can see from this graph“
So given the randomness in that data, patience when investing is needed. Stay the course and be rewarded.
Best Wishes
What I’ll note, however, is that author Adam Grossman (in Ted’s linked article)) appears to advocate for considerable latitude in allowing emotions to intervene. Grossman specifically lists 5 reasons why emotions might be allowed to interfere with allocation decision making (math be damned).
Here’s those 5 reasons in Grossman’s words (edited for brevity) :
1. “All math involves (possibly flawed) assumptions. If the math says your portfolio can afford maximum risk, ask yourself what assumptions underlie that calculation. ... If you look back at U.S. stock market history, downturns generally result in losses of 20% to 50% and last two to four years. But notice that I said “generally.” During the Great Depression of the 1930s, the market dropped more than 80% and didn’t fully recover for more than a decade.”
2. “Just because something hasn’t happened recently — or hasn’t happened here — doesn’t mean it can’t happen. ... Consider Japan. In 1989, it was on top of the world. Its economy and stock market were soaring. But over the subsequent two decades, the Japanese market declined more than 80%. Even today, nearly 30 years later, the Nikkei index stands almost 50% below its peak. ...”
3. “(Consider) ... if something happened — a health issue, for example — and your expenses increased? These kinds of things are impossible to predict, but I think it makes sense to allow for the unexpected when structuring your finances.”
4. “You might not know your true tolerance for risk. ... If you haven’t yet lived through a true bear market, when all the news is relentlessly bad, you might want a more moderate asset allocation than the math suggests.”
5. “It might be unnecessary. ... If you have the risk dial set to 10, ask yourself whether you’re swinging for the fences, even though you’ve already won the game.”
Ted’s link (restated for attribution of quotations): https://humbledollar.com/2019/06/math-vs-emotion/
Indeed, Grossman’s logic is confusing and not especially helpful.. He does a bad documentation job. To steal the format of one of your closing comments “(Grossman) be damned.”
Thanks for your contribution.
Best Wishes
There is NO single “right asset allocation”. There are far too many unknowns and variables. So it all depends on factors that are far too complicated to predict with any accuracy.
What to do? To get a general feel for possible outcomes Monte Carlo simulations will help. I’m at least consistent in that regard. Please give that tool a few test runs. The output that simulation generates might just both surprise and inform you. Here is a Link to just such a tool that allows for easy exploration of many possible investment scenarios:
https://www.portfoliovisualizer.com/monte-carlo-simulation#analysisResults
Portfolio failure rates will be unacceptably high if an investor only goes the “safe” route of bonds. Equity outcomes vary greatly but yield outputs needed for portfolio survival. Risk is part of survival.
Really good and useful stuff. I hope you take advantage of it.
Best Regards