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RP: We often read in the financial media about strategic asset allocation. It’s essentially about predicting which asset classes are about to perform well, and which will fare poorly. But it’s extremely difficult to do. Former hedge fund manager Victor Haghani says most investors should simply choose a suitable asset allocation and stick with it.
VH: A static asset allocation gets you so far to the optimal that it really is the practical thing for almost everybody to do - to choose an asset allocation that they think they’ll be comfortable with over the long term. So, that’s kind of bringing their own risk version and then sticking to it. It’s simple, it’s easy to implement, it’s easier to stick to, it takes out our demons that get into our head as we see what’s going on in the world around us and it gets us most of the way, very much most of the way, to an optimal solution. So, I think, that’s what most people should be doing.
RP: But there is a problem, your asset allocation will automatically change over time. For example, equities go on a good run, then they’ll form a bigger part of your portfolio as a result. That’s why it makes sense, periodically, to rebalance, and restore the original asset allocation.
VH: We have to rebalance, otherwise we drift away from where we want to be. And even if rebalancing incurs the cost of paying taxes now, that you might otherwise pay in the future, getting to where is right for you is really quite important. I mean, having too much risk or too little risk is okay when it’s a little bit. But when it starts to move quite far away, it’s really a very big cost to your expected utility, your expected risk readjusted return or just to what you should be getting.
RP: Opinions vary as to when or how often you should rebalance. The important thing, says Victor Haghani, is just to do it.
VH: Whether it’s quarterly or annually, I don’t think it matters that much, as long as it’s done. I think it’s important, also, to do it in a disciplined way - you know, not to do it as a backdoor way of expressing your subjective views about what is going to happen to the market.
RP: The best thing, then, is to choose the appropriate asset allocation and simply rebalance periodically. Don’t be tempted to try to second-guess the market and change it.
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