Asset allocation or stock picking: What’s the best strategy?
Over the years I’ve met a few people that assume I am an investment guru, able to consistently select investments just before they take off to make 2x, 3x or more on the original investment.
Nothing could be further from the truth.
While I think I make wise investment choices, few professional investors are able to consistently beat the broad stock market averages. I like to think of myself as more of a “slow and steady wins the race” kind of investment professional.
In my view, investing has never been about picking the best performing stock just before it rockets higher. It has been about a broad strategy of looking for long term growth across a range of investments, spreading risk, and building a portfolio that won’t fall apart as soon as the Dow Jones Industrial Average has a dip. Its about meeting client goals to retire at 65 or put their kids through the college of their choice. Sometimes, it is about transforming a person’s financial life. This last one is why I am a financial planner.
Yet, many investors struggle to develop a disciplined investment strategy that they can stick with through good times and bad.
My real world experience with investors has been as follows:
1. When the stock market has had several years of strong back-to-back performance (such as 2023 and 2024), I’ve had a few prospective clients say that they believe they can manage their investments on their own. I’ll call them the “overconfident investors.”
2. The other situation has been when stocks have performed poorly. When that happens, I have received more inquiries and taken on more new clients. I’ll call those the “no confidence investors.”
From my experiences it seems that investors are sometimes overconfident in their abilities because of a few winning investments while others give up when they get discouraged by a down market.
Anyone can make money when the market is going up
In fairness, I bring on new clients every year, but when the stock market is in one of the two above scenarios, I notice an attitudinal difference with the way investors talk about investing. It is worrisome for me to hear them talk this way because it indicates a short-sightedness or perhaps limited investment experience.
Investing successfully is a marathon. It is a long-term project requiring commitment through changing market conditions. It can require counter-intuitive decisions that can require courage. Investing is made harder by its daily ups and downs and the difficulty of predicting—with any degree of accuracy or consistency—where it is headed next. And many investors do not have a system or plan to manage their investments. Such as, do you review each of your investments every quarter and evaluate whether it is meeting the goal that caused you to purchase it?
Right now investors are feeling pretty confident about the stock market because they made so much money over the last two years. But now many US stocks are expensive compared to how much money they are making. If certain stocks are more expensive than all the rest, should you keep buying more? What if the company stops growing at an exponential rate? What if investors start thinking that a stock cannot go any higher or, worse, that it is overpriced? As stocks of some US companies have reached record high valuations, the risk of a price correction typically increases. Will it happen? –Yes, it’s just a matter of “when.”
What can you afford to lose?
While you might like picking stocks of small, emerging companies, would you do that with your mother’s / grandmother’s social security benefit each month? If she is relying on those deposits to pay her bills and buy food, it would be irresponsible to be investing it in high-risk stocks. Why? Because of the risk of a permanent loss for your mother / grandmother. She cannot afford to take that risk.
Which leads me to: Should one focus on asset allocation or stock picking?
The answer is, of course, you should focus on both.
When we are building investment plans for our clients we start with the big picture:
“What are you investing for?”
“Do you have a goal in mind?”
“If so, what is it and when will it happen?”
“How important is achieving this goal?”
“What will happen if you do not achieve it by your deadline?”
Building an investment plan
With the answers to these questions, we develop a framework to construct an investment plan. Each investment plan has certain risk and return characteristics based on investor goals and circumstances. Some investors need income to live on; others don’t need income but want their investments to grow as much as possible; and others may need to save and invest for their retirement or a child’s college education in a few years.
In designing an investment plan we include different types of investments from many different stock and bond categories: foreign developed markets, emerging markets stocks, US large companies, US small companies, high yield bonds, investment grade bonds, foreign bonds, etc. We allocate assets to each based on the investor’s risk and return profile and additional information we have gathered from our meetings with them.
Another dimension is to consider which industries are represented in the allocation strategy such as: industrial, utilities, technology, financial, healthcare, consumer discretionary, etc. Each category has its own risk and return characteristics, and each client has their own needs for return and tolerance for risk.
Asset allocation: Where it all begins
Roger G. Ibbotson is one of the most well known pioneers of asset allocation strategies. His academic work is often referenced as the source of the following statement: ‘Asset allocation is responsible for 90% of an investors’ return.’ Some investors believe this implies that having the right asset allocation is more important than picking the right stocks.1 Certainly considering the bigger picture of an investor’s needs and goals is a broader—and I would argue—a more effective approach to managing one’s finances than just picking good stocks.
In my experience, allocating assets across a range of investment categories and types has greater potential to provide the returns an investor needs within an acceptable range, risk-wise.
If you are trying to develop a proper investment strategy that is appropriate for your needs, this process can get complicated quickly. If you would like to review your investment approach, give me a call. I’m here to help. You can schedule a quick call with me by clicking HERE.
Lyman H. Jackson
Lyman@PlanWithFPS.com
617-653-3303
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1There are lengthy and detailed discussions online about the shortcomings and misapplications of Mr. Ibbotson’s original work. His own perspective on this debate is highlighted in the Financial Analysts Journal, vol. 56, 2000, issue 1, https://www.tandfonline.com/doi/abs/10.2469/faj.v56.n1.2327
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