While the fact that where you are determines the majority of your return is correct, it also determines the majority of risk and loss.  Get your asset allocation wrong and you may not be experiencing return, but loss.

The following gives a brief assessment of things that you need to understand when considering the simple asset allocation arguments.

1. The figures from these studies are long term averages taken from large samples.  Such an average over a long period of time should more or less be representative of the broader market index and hence the result is merely a tautology - that is an allocation of funds over a long period of time that more or less mirrors that of the market is going to more or less act like the market.

   The asset allocation studies say little about well resourced and well disciplined managers who takes contrary positions to the market index based on valuations.  Indeed, well disciplined managers should be able to out perform the index over time. 

2. The studies provide a valid argument for not using a good majority of the wealth managers who lack the necessary discipline, expertise or resources to beat the index over time and, a good argument for using index investments as opposed to the majority of active funds. See Investment Discipline under attack for further information. 

   For investors with conventional performance risk preferences, that is they do not want to under perform the market, index investments are good ideas, irrespective of the arguments from the asset allocation studies.  

3. This simple asset allocation argument does not help you to determine the allocation to cash and fixed interest investments.

   For one, you need to be able to relate the portfolio structure to the size and timing of financial needs. Secondly you need to be able to manage the allocation between cash, fixed interest investments and equities, which requires investment discipline and the ability to value. 

   While you can indeed use index allocations to get your equity allocation, you need to be able to value the allocation in order to manage it. 

   In fact, using allocation vehicles to allocate to areas which you can value but do not have the specific expertise and resources to manage directly, is the most appropriate use of asset allocation.

4. This simple asset allocation argument does not help you allocate globally.

   In order to be able to allocate to global markets you need to be able to determine the valuation of these markets, otherwise how do you know how much to invest in each market.

   Again, using allocation vehicles to allocate to global markets which you can value but do not have the specific expertise and resources to manage directly, is the most appropriate use of asset allocation.

5. It does not help regarding the initial risk of investment.

   If markets are at high to extreme valuations the simple asset allocation argument is going to place the individual at extreme financial risk. 

   It is perfectly acceptable for an asset manager to allocate to asset classes (say the main market index, or smaller companies, or technology) through an index fund or another asset allocation vehicle.  But, if the manager cannot value those asset allocations, then they cannot determine how much you should have in them or why you should be in them at all.

   Simple asset allocation arguments therefore violate a primary investment discipline; that of knowing the value of an investment both in absolute and relative terms.

6. The index is not an efficient manager of risk and return.

   Merely allocating to the market or a global market index is not enough. Investors in the broad market indices in the late 1990s were unwittingly exposed to the collapse in technology, media and telecommunication stocks that had come to represent very large weightings in the index.  Take the Canadian stock market and the weight of Nortel in the index as a case in point.  At its peak, Nortel represented some 30% of the Canadian stock market.

   To manage risk and return effectively, you need to be able to value all components and weight accordingly.   In this context using asset allocation vehicles to access under valued components and to under weight over valued components is a much more efficient use of asset allocation's arguments, but again relies on valuation expertise and investment discipline.