Section 6.1

Allocation Logic

Some people speak of asset allocation within a portfolio as if it were of mystical significance.  If you can just find the magic proportion of ingredients and proportions, then you can build a portfolio that will withstand Armageddon and still make a large profit.

You may have heard the earthy wisdom of “Plan your work and work your plan.”  This is sage advice.  Most successful investors will tell you that most of the time, you should just stand there and do nothing as the markets melt down, and fortunes are lost.  By following your asset carefully crafted allocation plan with courage and conviction, you will almost assuredly retire with more money than you need.

A prudent asset allocation that is followed by discipline will increase your chances of reaching and maintaining financial security over your lifetime.  That being said, no investment strategy can protect your portfolio all the time.  When we plan portfolios, we tend to use “smoothed” metrics like regression lines that clearly point upward.  In the day-to-day life of securities, prices can fluctuate wildly.  You must be prepared for some bumps in the road.  There will be poor months, quarters, and occasionally years.

We can quantify market risk with some impressive looking statistics; these are extremely valuable tools.  When it comes to risk tolerance, there are no rules.  Risk tolerance is all about you and how certain conditions make you feel.  Perhaps the most commonly used risk assessment tool in the practical world is the “sleep test.”  Before you add a security to your portfolio, you need to discern how volatile it is, how much you can gain, and how much you can lose.  If your strategy consists of “buy the SPY,” you must be a risk seeker in the extreme to withstand a 50% drop in the S&P 500 and still get a good night’s sleep.

From a strictly logical, probability centered point of view, you shouldn’t care what the market does in the short term when you have 25+ years until you can retire.  It shouldn’t matter that the market has corrected and that you’ve lost thousands of dollars.  Two hundred years of market history has taught us that the markets have a bullish bias, and if we wait long enough, it will come back.  Logic doesn’t always help one sleep at night.  We are human beings, and as such, we are creatures of emotion, driven to invest by the need to retire in comfort, and constantly fighting to stay calm in the ongoing battle between greed and fear.

The situation isn’t made any better by the vast number of charlatans out there that want to sell you a “secret strategy for building enormous wealth.”  When someone tells you that you can gain “wealth without risk” in the market, they are either misinformed or lying.  Always remember: There is no free lunch on Wall Street.


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Last Updated: 6/25/2018