|  Roger Ibbotson is chairman and founder of Ibbotson Associates, a leading authority on asset allocation, providing products and services to help investment professionals obtain, manage and retain assets. The company's business lines include asset allocation, investment consulting and planning, analytical and wealth forecasting software, educational services and a widely used line of NASD-reviewed presentation materials. Mr. Ibbotson is also a professor in the practice of finance at the Yale School of Management. How to manage your asset allocation -
Invest in stocks for the long run. Several studies suggest that future stock returns will be much lower than past returns. In fact, one study even suggests that the future equity risk premium is negative, meaning that stocks will not beat bonds in the future. Our research shows, however, that of the 11 percent that the market returned each year over the past 75 years , only 1.25 percent was from an increase in the P/E ratio - the rest was from actual earnings growth. While changes in P/E ratios are largely responsible for returns in the short term , they are highly volatile and unpredictable. In contrast, growth from corporate earnings accounts for returns in the long run and is relatively stable. There is good reason to believe that stocks will continue to provide significant returns over the long run. -
Asset allocation is the most important of all investment decisions. On average, investors don't beat the market, which means that the asset allocation mix accounts for 100 percent of the return on an average portfolio. Of all the decisions investors make, therefore, the asset allocation decision is the most important. Typically, 40 percent of the return difference between one fund and another is explained by asset allocation differences, while the remaining 60 percent difference is explained by security selection, timing and fee differences between the funds. -
Diversify across and within asset classes. The extended superior performance of large cap growth and technology stocks through the last half of the 1990s lulled investors into a false sense of security. If 2000 taught us anything, it's that hot stocks and asset classes are difficult to predict and equally hard to time. Returns, historically, tend to come in spurts that make momentum investing and market timing unreliable investment strategies. Investors should heed the old adage, 'Don't put all of your eggs in one basket .' -
Invest globally. Although the correlation between the U.S. and international markets is rising , that's no reason to reduce international exposure. The United States only accounts for approximately half of the world's market. Americans traditionally allocate far too little to international markets, cutting off a huge portion of the investment universe. The correlation is still relatively low and continues to provide substantive diversification to investors' portfolios. -
Minimize costs. The costs associated with purchasing investments are certain, but the returns of those investments are not. And, over time, high returns in one year tend to cancel out low returns in another, but costs just compound. Differences in fee structures explain much of the performance difference between two funds over the long run. Paying close attention to the cost structure of an investment will increase total return. -
Limit the impact of taxes. Know how different types of gains are taxed and hold them in the appropriate accounts. To capitalize on the full benefits of tax-deferred or exempt accounts, make the maximum contributions and hold highly taxed assets (such as taxable bonds, dividend-producing equities or mutual funds with high trading activity) in these accounts to defer realization of capital gains as long as possible. Hold long-term investments in taxable accounts. -
Keep a composite record of your total wealth and accounts. It's easy to fixate on the big winners and the big losers in one's portfolio rather than the portfolio as a whole. Every portfolio should have winners and losers - that's the sign of a well-diversified portfolio. If you concentrate on the total performance, you will stay focused on your long-term goals. -
Evaluate and rebalance your portfolio regularly. Investors should evaluate their portfolios each year to determine if their asset allocation has significantly changed due to the price appreciation or depreciation of their investments. Rebalancing will help keep an investor on track to achieve his or her long-term goal and can help reduce risk. Investors with an allocation in technology stocks, for example, who did not rebalance annually during the tech runup took a much bigger hit during the decline than those who rebalanced. -
Plan your investments to cover your liabilities. We sometimes lose sight of the goal of investing, which is to accumulate wealth to finance various consumption needs. Whether it's retirement or college tuition, investors must consider how far away the liability is in time, the rate at which it is increasing and the likelihood that the chosen investment vehicle will be able to meet the liability when it's due. -
Invest over your life cycle. Reduce your allocation to equities as your investment horizon decreases. However, don't get out completely. People are living longer and facing many costs, like healthcare, that are rising faster than inflation. Even retirees need to have a portion of their portfolios allocated to stocks in order to finance retirement. www.ibbotson.com 'As attractive as the concept might sound - generally something like buy global winners to capture the benefit of international markets without the risk -- the reality is that one does not get the diversification advantage of foreign stocks with multinationals. Domestic MNCs tend to have a beta close to 1.0 with their home market, and large-cap global MNCs are usually the most highly correlated both with each other and with large developed markets.' ”Steven Schoenfeld | |
