On April 9th SmartMoney ran a story about asset allocation called Why Asset Allocation May Not Matter. Although the article did contain some interesting alternative views on the subject, it would be a mistake for most investors to follow the dangerously irresponsible advice contained therein. Here are some excerpts from the article, followed by my comments.
“Are you worried about having the right mix of stocks and bonds in your nest egg? A new study indicates that asset allocation might not be as important to your long-term financial health as making better use of other retirement-planning tools, including working longer, controlling spending or taking out a reverse mortgage.”
This is a case of comparing apples to oranges. Proper asset allocation can not be compared to working longer, spending less, or taking out a reverse mortgage. Allocation an investment strategy, not a lifestyle choice or a financial product. If an investor gets the impression that he or she doesn’t have to pay attention to asset allocation because it’s not as important as these other activities, then the author has done a great disservice. The article continues…
“The report, from the Center for Retirement Research at Boston College, is titled, appropriately enough: “How Important Is Asset Allocation to Financial Security in Retirement?” The various holdings within a person’s retirement accounts typically play an early and prominent role in dealings with financial advisers. But given the relatively small size of most nest eggs (less than $100,000 for those approaching retirement), researchers at Boston College set out to determine whether other “levers” could have an equally large – or larger – effect on financial security in later life.”
The use of the term ‘levers’ is revealing. Asset allocation is a strategy, not a lever. If working longer or spending less is a lever, that’s o.k. with me. But doing these things has nothing to do with asset allocation. Continuing with the article…
“With all three exercises, the findings were essentially the same: Asset allocation played a relatively minor role in creating a secure retirement. The one exception, in some instances: households in the top decile of wealth distribution (more than $500,000). But even here, the study notes, the “importance of asset allocation was…less than one would expect.”
Once again, the author is asserting that the asset allocation decision is an alternative to the lifestyle decisions, as opposed to a completely separate process. The article…
“The upshot: Financial planning tools, the report concludes, “frequently highlight the asset allocation decision, suggesting that individuals have a lot to gain by adopting a more optimal allocation of stocks and bonds.” But financial advisers “will be of greater help to their clients if they focus on a broad array of tools – including working longer, controlling spending, and taking out a reverse mortgage.”
Here we clearly see that the author is equating all of these activities as financial planning tools, and implying that they have equal standing in the retirement planning process. But they are not the same kind of tools at all. The asset allocation decision is independent of the other financial planning tools described in the article.
But perhaps the most offensive part of the article is the implication that a reverse mortgage is not only a good retirement planning tool, but also a more important alternative to asset allocation. This is just wrong on every level. Investors will be best served by paying careful attention to their allocations, and not falling for the traps that are being set by this dreadful advice.
You can read the entire study here.