Asset allocation: balancing financial risk

386 Pages·2008·5.72 MB·English

by  Roger Gibson

A s s e t
Allocation
BALANCING FINANCIAL RISK
Fourth Edition
ROGER C. GIBSON
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DOI: 10.1036/0071478094
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Th is book is dedicated to my wonderful family:
Brenda, my wife
Sarah, Caitlin, and Adam, our three children
I am a lucky guy.
Th e royalties from this book will be donated to the
Roger and Brenda Gibson Family Foundation
in memory of my father, Don B. Gibson,
and in honor of my mother, Marianne A. Gibson.
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Contents
Foreword to the Fourth Edition vii
Foreword to the First Edition xi
Acknowledgments xv
Introduction 1
1 The Importance of Asset Allocation 7
2 U.S. Capital Market Investment Performance:
An Historical Review 19
3 Comparative Relationships Among U.S. Capital
Market Investment Alternatives 51
4 Market Timing 69
5 Time Horizon 87
6 A Model for Determining Broad Portfolio Balance 103
7 Diversification: The Third Dimension 127
8 Expanding the Efficient Frontier 157
9 The Rewards of Multiple-Asset-Class Investing 179
10 Portfolio Optimization 205
11 Know Your Client 233
12 Managing Client Expectations 245
13 Portfolio Management 285
14 Resolving Problems Encountered
During Implementation 331
Conclusion 353
Index 357
v
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Foreword to the
Fourth Edition
Experienced investors all understand four wonderfully powerful truths
about investing, and wise investors govern their investing by adhering to
these four great truths:
1. Th e dominant reality is that the most important decision is your long-
term mix of assets: how much in stocks, real estate, bonds, or cash.
2. Th at mix should be determined by the real purpose and time of use
of money.
3. Diversify within each asset class—and between asset classes. Bad
things do happen—usually as surprises.
4. B e patient and persistent. Good things come in spurts—usually
when least expected—and fi dgety investors fare badly. “Plan your
play and play your plan,” say the great coaches. “Stay the course” is
also wise. So is setting the right course—which takes you back to
great truth 1.
Curiously, most active investors—who all say they are trying to get
better performance—do themselves and their portfolios real harm by
going against one or all of these truths. Th ey pay higher fees, costs of
change, and taxes; they spend hours of time and lots of emotional
energy; and they accumulate “loss leaks” that drain away the results
they could have had from their investments if they had only taken the
time and care to understand their own investment realities, develop a
sensible long-term program most likely to achieve their goals, and stay
with it.
Th e importance of being realistic about investing continues to increase
because the markets are increasingly dominated by large, fast-acting, well-
informed professionals who are armed with major advantages. During
vii
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viii Foreword to the Fourth Edition
the past generation, to cite a few examples, the following basic changes
have taken place:
• Institutions have gone from executing 10 percent of all trades to
90 percent.
• Exchange volume, using the NYSE as an example, has mushroomed
from 3 million shares to 1.5 billion shares, and derivatives volume
doubles that to 3 billion shares—a thousand-fold increase.
• Th e 50 largest institutions now do half of all trading, so when an
individual buys or sells, half the time she is trading against one of
the fast, smart giants. Sure, the individual may win sometimes, but
can she win regularly?
Even the pros fi nd it very hard to beat the market. Over the last 5, 10,
or 20 years, more than half got beaten by the market. For individuals, the
grim reality is far worse.
“If you can’t beat ’em, join ’em.” Th at is why indexing has become so
widely accepted. An even-better reason for individuals to index is that
they are then free to devote their time and energy to the one role where
they have a decisive advantage: knowing themselves and accepting
markets as they are—just as we accept weather as it is—and designing a
long-term portfolio structure or mix of assets that meets important tests:
1. Th e investor can and will live with it.
2. Th e long-term, reasonably expectable results will meet the investor’s
own priority.
While some few investors are so skillful, so well supported, and so
independent that they really can add value by actively changing their
investments, the records show over and over again that their number is
fewer than most investors are willing to believe. For the individual, the
chances of identifying one of these great winners before their record has
been established is very low.
Changing managers—fi ring one before disappointment and hiring
a new one before success is shown—is virtually impossible. Such “dat-
ing” should be recognized as an expensive waste of time and energy and
avoided by all serious investors.