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:
Finally, here is a summary of Efficient Frontier's Links of the Month:
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.
- FINWEB Homepage -- A superb compilation of commercial and noncommercial sites.
- Financial Data Finder -- Contains a separate section for downloadable data.
Financial publications -- Just about all major financial publications, including The Wall Street Journal and Barron's, to name a few, have online versions. Unfortunately, the aforementioned are now pay sites although the price is reasonable—$29 for both if you are a print subscriber to either, $59 if you are not. The Journal of Finance makes available full-length portable document format (PDF) versions of most major articles months in advance of formal publication. About 90% is mathematical and arcane beyond belief. Fortunately, if an article is really worthwhile it doesn't require camouflaging with complex formulae; often these pieces are written in plain English. The site is definitely worth visiting a few times a year. The Review of Financial Studies Online is another excellent freebie for advanced readers.
- Research Journals in Finance -- Links to the major finance journals.
Contingency Analysis -- Very sophisticated site devoted to risk analysis, derivatives, and portfolio theory.
Tamasset -- A no-fee financial advisor's site with an excellent newsletter as well as a good investment and asset-allocation bibliography.
- 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.
- April 1997: Will Goetzmann's Online Text
- January 1998: ICI Mutual Fund Fact Book (Updates Every Year)
- April 1998: Financial Engines
- September 1998: What Has Worked in Investing (Tweedy Browne)
- April 1999: DFA's Website
- September 1999: Robert Shiller's Historical U.S. Market Valuation Data
- Winter 2000: Andrew Tobias' Fund Expense Calculator
- Summer 2000: Paul Krugman's Op Ed Columns from the NY Times
and Fortune Interview of Warren Buffett
- Fall 2000: Tobin's Q from Wright and Smithers
- Winter 2001: Ken French's Database
- Spring 2001: T. Rowe Price's Retirement Calculator
- Summer 2001: Face Time with Ken French and Gene Fama
- Fall 2001: Rothbard's The Mystery of Banking
- Winter 2002: Maddison's The World Economy: A Millenial Perspective
- Spring 2002: Hamilton and Burns' Reinventing Retirement Income in America
and John Scordo's Tracking of Current Working Papers in Finance
- Summer 2002: Kathleen Kahle's When a Buyback Isn't a Buyback
- Fall 2002: Chan, Karceski, and Lakonishok 's The Level and Persistence of Growth Rates
- Winter 2003: Kamstra, Kramer, and Levi's Winter Blues: A SAD Stock Market Cycle
- Summer 2003: David Warsh's economicprincipals.com
- Fall 2003: Rajan and Zingales' The Politics of Financial Development in the 20th Century
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