Does Asset Allocation Still Work?

…and if so, when?

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The Great Panic of 2008 prompted many articles claiming asset allocation does not work anymore. Both stocks and bonds dropped in value during the initial sell off, delivering a 20% loss to even a moderately allocated portfolio in 2008. The fact that stock and bond prices have since recovered has not detracted from research proclaiming the death of asset allocation.

A 2012 study from the Center for Retirement Research at Boston College titled: “How Important is Asset Allocation to Financial Security in Retirement?” (PDF) compared asset allocation along with three other variables – working longer, spending less, and reverse mortgages. The purpose of the study was to determine the impact each variable has on a retiree’s ability to maintain their lifestyle during retirement. The study concluded asset allocation has the least impact, while working longer has the greatest impact. Does this mean asset allocation is worthless?

The problem with this study is the use of an average 55-64 year old American with a median net worth of just over $179,000. Assuming a sizeable part of their net worth is their home, this leaves a relatively small amount of investable assets. The investable assets would contribute an insignificant amount to retirement income. Therefore, asset allocation would not have a meaningful impact on retirement income in this situation. This person will need to work longer.

Asset allocation has a more meaningful impact on the sustainability of retirement income when investable assets produce a sizeable amount of income. When more than 50% of retirement income is being produced by investments, asset allocation is critical to assure income grows to keep pace with inflation. Ideally, the assets will also be broadly diversified to give the portfolio exposure to investments currently in favor. Rebalancing periodically will help maintain the current allocation to avoid becoming overweighted in any one asset class.

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