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
-
Secure Your Legacy: Why Naming a Beneficiary for Your 401(k) Matters
When you participate in a 401(k) plan, you’re taking a significant step toward securing your financial future. But there’s an equally important, often overlooked, aspect of managing your plan: naming a beneficiary. This simple action ensures your loved ones are protected and minimizes complications if the unexpected happens. Here’s why it matters for both you…
-
A Memo from our Chief Investment Officer | March 2025
Market headlines can be overwhelming, especially in times of uncertainty. At Evensky & Katz / Foldes, we understand that economic shifts, policy changes, and market fluctuations can trigger real concerns about your financial future. In the letter below, our Chief Investment Officer, Lane Jones, shares insights on the current market environment, the impact of recent…
-
Ways to Talk Yourself off the Ledge When the Entire Market Seems Like it’s Falling to Pieces
Nobody likes to see their investments decline, especially during retirement when going back to work may not be an option. The first step is not to panic. Staying calm and rational can help you make better decisions. Market volatility is normal, and remember, markets can shift quickly in the other direction. In fact, 70% of…
-
Our Prediction Addiction
If you’ve ever felt the thrill of calling the market right—or the sting of getting it wrong—you’re not alone. As humans, we have an innate desire to predict, to control, and to feel like we’re ahead of the game. But here’s the hard truth: predicting the market is, more often than not, a fool’s errand.…
-
Roth vs. Pre-Tax 401(k): Which Contribution Strategy is Right for You?
When it comes to saving for retirement, one of the most important decisions you’ll make is whether to contribute to a pre-tax or Roth 401(k). Your choice could have a significant impact on your future tax situation, and understanding the difference is key to making the best decision for your financial future. In this post,…