The Online Asset Allocator

William J. Bernstein

What the Investment Industry Doesn’t Want You to Know

It’s a fact: you can positively impact only one aspect of investment performance—your allocation of assets among broad asset classes. Stock or mutual fund picking and market timing, the things traditionally thought to be critical to investment success, turn out to be almost irrelevant. How can this be?

Over 10 years ago, Gary Brinson, a noted finance academic and money manager, studied a group of pension fund managers. He found that he could explain over 90% of the differences in variability among these investment professionals simply by classifying them according to how much of their assets they placed in stocks, bonds, or cash. Stock picking or market timing skill? Try as though he might, he found no evidence of either among these investors practicing their craft at the apex of the profession. The significance of this for small investors is profound—find the right mix of foreign and domestic stocks and bonds, and your choice of individual securities becomes almost irrelevant in the long run.

How the investor arrives at the right mix is called portfolio theory, and until recently small investors had precious little guidance in this vitally important area. How difficult is it to find the right mix? Surprisingly easy. Consider this: If over the past 10 or 20 years you had simply held a portoflio consisting of one quarter each of indexes of large U.S. stocks, small U.S. stocks, foreign stocks and high quality U.S. bonds, you would have beaten over 90% of all professional money managers and with considerably less risk. The amazing truth is that over a long enough time period almost any reasonably balanced indexed strategy will best the overwhelming majority of professional managers.

Asset Allocation: The Basics

Sadly, most investment information available on the Web falls into the category of financial pornography—the supposition that investing success is acheived by predicting the direction of the market and picking the right stocks. In turn, it is supposed that this can be accomplished by engaging the services of a select group of investment professionals (of which the interviewed/quoted analyst/newsletter writer is a member). Almost no electronic ink is devoted to what turns out to be the main event: asset allocation. The Web is not entirely devoid of worthwhile material. There are at least two books on asset allocation available:

Investing for the 21st Century —An educational and entertaining investing primer by Frank Armstrong, a Miami financial advisor. Start with Chapter 22, a wonderful sendup of Lou Rukeyser. Hopefully, after reading this you’ll never listen to another financial commentator. I’d strongly recommend downloading and storing the book: it’s likely to appear in print soon and Frank’s publisher may not take kindly to the Web version.

The Intelligent Asset Allocator —It’s written by yours truly, so I can’t impartially review it. Since its publication by McGraw-Hill, I’ve had to take down most of it, but the first two chapters are still on the Web.

There are several other sources of basic investing information available on the Internet:

Scott Burns’ Archive —Scott is a syndicated business columnist based at the Dallas Morning News. His collection of articles is a treasure trove for neophyte investors, and includes the original Couch Potato Portfolio.

The Vanguard Group Educational Area —A superb source of basic information about investing and asset allocation.

Investor Home —An extensive collection of investment links, basic allocation info, and discussion of various finance topics.

If you really want to become proficient at asset allocation you are going to have to log off the ‘net, power down your computer, and go to the bookstore or library and spend several dozen hours reading books. For those who are interested, I have put together a structured study guide and reading list. No pain, no gain. Don’t shoot me, I’m only the messenger.

For the More Advanced Investor

If you already have a good grasp of asset allocation and portfolio theory, several sites are worth visiting:

Efficient Frontier — A quarterly online journal of asset allocation and portfolio theory aimed at both small and institutional investors.

Campbell Harvey’s Homepage — A snazzy frame-based site produced by one of today’s most prolific finance academics. A real treasure trove. It even has its own mean-variance applet.

Kiwi Club — The Finance Department’s site at the University of Texas.

BARRA International and Ibbotson Associates — Snazzy homepages for two of the premier for-profit finance think tanks. Both contain a section of superb research papers.

Global Financial Data Home Page — Want the really big picture, like global stock and bond returns over the past several centuries? Want to know about Peruvian stock returns from World War I? (Actually, you don’t want to know this one.) It’s all here. A must for the returns-data junkies out there.

Bloomberg — At the other end of the spectrum, if you want to know how the Philadelphia Gold Index or the Polish Zloty has been doing for the past hour, this is the place for you.

Finally, here is a summary of Efficient Frontier ‘s Links of the Month:

and Fortune Interview of Warren Buffett