The next time your advisor says "92% of returns...."

The next time you hear your advisor say "92% of your returns comes from asset allocation" ask them what that means. Just say "explain that to me." Have them walk you through it in detail.

I'll bet you $5 they won't have a clue....not a chance. Some advisors out there do, some get it inside and out. But they are few and far between and I'd guess about <5%.

Most advisors are unaware of what they are actually misquoting, who wrote it, or what it means. By reading this post you'll move to the head of the class.

Here is the quote:

"Specifically, data from 82 large pension plans over the 1977–87 period indicate
that investment policy explained, on average, 91.5 per cent of the variation in quarterly total plan returns."

The quote is from an article, a study really, by Gary P. Brinson, Brian D. Singer and Gilbert L. Beebower, written in 1991, in the Financial Analysts Journal. ( http://tinyurl.com/bdmgug pdf )

This article was a follow-up to a similar study they did in 1986.

The KEY point, which I bolded above, is that investment policy ( asset allocation ) explains 91.5% of the variation in returns !

It does NOT explain or determine WHAT your return will be....just how VOLATILE it will be...or how the returns will vary. That's it.

Example = If your asset allocation is 100% cash, the variability of your returns will be not so much. Cash does not move around in value. The interest rate may change, but that's it.

If your asset allocation is 100% stocks, or stock mutual funds, then the variability of your returns will be all over the map ! Because we know the stock market, even in 'normal' times, can be + 20% or - 20% within the same year.

So, asset allocation ( investment policy ) has everything to do with how your returns will be jacked around by the market, or by whatever major asset class you expose them too. No more, no less. Asset allocation does not predict, ensure, or make more likely a certain return %, nor does it guarantee you'll achieve an investment goal.

This is not to say that asset allocation is without merit. Not at all.

Asset allocation has plenty of merit, use and investment application.

It is unfortunately oversold as a solution and severely misunderstood. (9)