Staying the Course No Longer Works?
Ever since the market debacle triggered by the Great Recession, “Staying the Course No Longer Works” and “Modern Portfolio Theory Is Dead” have been popular headlines with the financial media. It sure sounds good; after all, why would any investor willingly subject their portfolio to the massive losses of 2008 and early 2009? They wouldn’t, of course; so does that mean that long-term strategic investing is out the window? One of the core beliefs at Evensky & Katz / Foldes Financial Wealth Management is that to earn market returns an investor needs to be in the market. Is that yesterday’s story? Needless to say, our investment committee takes these considerations very seriously, and we regularly review our investment philosophy and strategies. What we’ve concluded is that a better headline for the critics of modern investment theory would be “The Pot of Gold at the End of the Rainbow.” Unfortunately, no one has yet discovered that pot. Here’s our take on the debate.
The critics claim that modern portfolio theory, asset allocation, and buy and hold are all equivalent concepts and all are passé. What surprises me is that the critics seem to believe they have just discovered the truth, when in reality a new group of “gurus” discovers the same truth after every bear market. These critics typically claim that “allocations are solely and simplistically based on projected historical data and traditional methodology that assumes valuation is irrelevant; they are determined at the beginning of the investment process and are never changed, except when they are rebalanced.”
Although unfortunately, it is true that many practitioners do in fact develop allocation models based simply on historical data, that is certainly not the case at Evensky & Katz / Foldes Financial Wealth Management. We heed the advice of Harry Markowitz, Nobel Laureate and the father of modern portfolio theory. In his seminal work, Professor Markowitz wrote, “The first stage starts with observations and experience and ends with beliefs about the future performances of available securities.” He is quite clear in rejecting the approach of using historical projections. “One suggestion as to tentative risk and return is to use observed risk and return for some period of the past…I believe that better methods, which take into account more information, can be found.”
We certainly agree. When developing our recommendations for allocations to bonds and stock, we first develop forward-looking estimates for the returns, risk, and relative movement (i.e., correlations) of the various investments we will consider for our portfolios. While there can be no guarantee that these estimates will turn out to be correct, they certainly take into consideration not only the past but also the current market environment as well as expectations regarding future changes. For example, our projections for future returns are modest relative to past returns, our expectation regarding risk is that the markets will remain more volatile than in the past, and finally we believe that we live in an increasingly global world, so markets will move more in tandem in the future than in the past. The result is that the benefits of diversification will be diminished but not eliminated.
Regarding the criticism that allocations are determined at the beginning of the investment process and never changed, except when they are rebalanced—a strategy I call “buy and forget”—again, unfortunately, many practitioners do follow this ostrich-like policy. But this criticism should be leveled at the practitioners setting their policies in stone. There is nothing in the literature or in practice to suggest that a policy allocation should not be revisited and revised when and if forward-looking market expectations change. As a consequence, it is our practice to review our assumptions at least annually, and our “strategic” allocations do in fact vary over time as a result of changes in our worldview. Rather than “buy and forget,” our policy is “buy and manage.”
The bottom line is that some may develop allocation models based solely on projections of historical data, but we do not. Some may also ignore valuations; again, we do not. And some may design allocation models and set them in stone; we do not.
Feel free to contact Harold Evensky with any questions by email: [email protected]
Visit us at www.EK-FF.com
Categories
Recent Insights
-
Before the Ballots: The Strategic Advantage of a SLAT During an Election Year
With less than 70 days until election day, the future of both the White House and the Senate hangs in the balance. Regardless of who wins, the ongoing challenges of rising federal deficits, unprecedented spending, and lower tax revenues could pave the way for higher taxes in the future. The estate tax exemption, which primarily…
-
Talk Your Chart | Fed Rate Cuts, Weak Recession Signals, and a Bull Market in Slow Motion| Episode 61
In Episode 61 of Talk Your Chart, Brett and Marcos explore the latest on the Dogs of the Dow, Utilities’ surprising rise, and Constellation Energy’s nuclear power dominance. Dive into the current bull market, Fed rate cuts, inflation signals, and why recession indicators remain weak.
-
Talk Your Chart | Monopolies, Markets, and Missteps: What’s Really Driving Prices? | Episode 60
In Episode 60 of Talk Your Chart, Brett and Marcos dive into the economics of price gouging, the role of monopolies, and whether price caps could be the answer to rising costs. They also explore recent nonfarm job data, capex spending by the Magnificent 7, and recovering consumer sentiment. Join the conversation on what’s shaping…
-
Understanding Form 5500: A Guide for Business Owners
When it comes to managing your company’s retirement plan, one of the most important responsibilities is filing Form 5500. This form is crucial for maintaining compliance and protecting both your business and your employees. Let’s break down what Form 5500 is, why it matters, and share some practical advice on what to do if you’ve…