Commentary: The key to success is asset allocation

In my 24 years of experience in the investment industry, the one thing that is constant is the belief on the part of many investors that they know how to time the markets.

That is, they believe they know when to over or underweight stocks versus bonds. The basis for their decision is a hot tip from a friend or broker, news in the media, general discussions around the office, personal fears, etc. While an investor may be acting in earnest, the truth is long-term performance will suffer with constant "tweaks" to the portfolio.

By the time financial news is reported, it is in response to actions already taken by investors -- it is old news and the specific opportunities being reported probably already diminished. Respected business publications have often sensationalized trends or opinions of experts, leading those who follow this kind of advice woefully off course.

As I educate 401(k) participants, I convey a message of simplicity: To achieve good long-term performance, one needs an appropriate asset allocation -- mix of stocks and bonds -- and a long-term perspective.

Let's look at asset allocation. This decision is important as it determines more than 94 percent of the variability of returns over time. If properly made, this allocation will not need to be changed much over time.

To set the right allocation, an investor needs to understand his investment time horizon. For example, the number of years until retirement. Remember, if you retire at age 65, it is estimated that a healthy individual can count on a life expectancy of two or more decades. It is important to consider this when investing for, and during, retirement.

The second point is to understand is that investing takes patience and time. This is not a game of "home runs," but rather one of consistent points scored throughout the years. A solid, high quality portfolio will perform well over time. Staying with a strategy through high and low markets will produce the best overall returns.

Watson Wyatt completed a study comparing investment returns for the 10-year period ending 2006 for defined benefit and 401(k) plans. Defined benefit plans are traditional pension plans from which participants are promised a specific dollar benefit per month at retirement age. Trustees are responsible for the investment of the plan's assets and investment portfolios tend to be balanced with an allocation of about 60 percent equities/40 percent fixed income instruments.

On the other hand, 401(k) plans normally allow participants to make their own investment decisions with multiple fund options and the ability to make frequent changes.

When looking at Watson Wyatt's study from multiple perspectives, including by the number of participants and the size of plan assets, the results are the same: On average, defined benefit plans outperformed 401(k) plans by 0.65 to 1.28 percent per year. The out performance of defined benefit plans is more than likely due to a few factors.

Defined benefit plans tend to be higher in value than 401(k) plans and, therefore, able to take advantage of investment options that may not be available to smaller pools of assets.

Because of their size, many defined benefit plans may be eligible for reduced investment fees.

401(k) plans often have record keeping/administration fees charged to plan assets, reducing investment returns.

Finally, and possibly most importantly, 401(k) participants often make investment decisions/allocations based on emotion and/or inappropriate or late information. Participants often become too aggressive or too conservative based on old news and become market trend followers. Rather than selecting and staying with a long-term allocation, participants often chase their tails in an effort to achieve higher returns. This leads to buying high and selling low and consistently produces sub-par performance, by as much as tens of thousands of dollars over the course of 10 years.

Participants need to keep decisions simple. The longer one has until retirement, the more risk he or she can assume. This means a willingness to risk losing assets in exchange for greater potential asset gains. Long-term investors can maintain a higher allocation to stocks.

Remember, also, to rebalance periodically. If your targeted asset allocation is 70 percent equities/30 percent bonds, and equities experience a strong rally through the course of a year or two, your allocation may become 80/20 percent. As a result, you should move 10 percent from stocks to bonds to rebalance the allocation back to its targeted level.

A professional investment manager has considerable financial education, experience, discipline and access to sophisticated investment tools. This knowledge makes a significant difference in the long-term performance of assets. Let your manager make the detailed investment decisions. Your job is to keep it simple:?Decide your allocation to stocks and bonds and stay the course.

Marijoyce Ryan, CPP, is vice president of fiduciary services for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford; phone (585) 586-4680.

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