Asset Allocation Won't Protect Your Portfolio in a Downturn

Asset allocation is supposed to reduce overall portfolio volatility by spreading your assets across different classes with limited correlation. Then why does your portfolio still drop in a downturn, no matter how much your advisor tweaks the percentages?

Globalization has increased the correlation between most asset classes. Just compare charts for a value and a growth ETF - they are virtually identical. No point in owning both, and little difference in owning either. 20 or 30 years ago, you could diversify your US stock holdings with some European stocks because when the US was in a recession, Europe could be booming, or vice versa. Not anymore. For example, if interest rates rise, they will rise globally, dragging down all bonds worldwide. Higher interest rates will also depress stocks, so all stocks will decline worldwide - some more, some less, providing varying degrees of pain but no protection.

Broad asset allocation is nothing more than a smokescreen for incompetence because superior returns are achieved by overweighting outperforming groups, not by tweaking percentages.

All a broad asset allocation guarantees is below market returns. If you hold large caps, mid caps, small caps, growth, value and a "core" index fund to boot, you own the market. What you get is the market return less management fees. If the market is up 10% and your investment management fees and expenses add up to 2%, you are ahead 8%. But if the market is down 10%, you are down 12%. If you invest in the market, you make less but lose more than it does. Hardly the path to a secure retirement.

Taking cues from the 2008 bear market, some advisors now see non-correlated assets in futures and collectibles. Too little, too late. The market never offers an instant replay on demand. Plus, most commodities move with the global economic cycle as well, and so do collectibles: people are more likely to spend more on luxuries in good economic times. You would have to be a real connoisseur to tell which wines will appreciate regardless of the global economic climate. I doubt the wholesale stuff they put into investors' portfolios will do that.

So what's an investor to do? Go back to basics. Stay attuned to the economic cycle by increasing and decreasing your market exposure as needed; and don't put all your eggs in one basket: diversify to protect against individual company risk by holding several stocks. But holding a bouquet of mutual funds of every shade won't shield you from the next disaster, nor will it make you rich.