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6 Reasons Why Asset Allocation Affects Investment Performance For Ultra-High Net Worth Investors More than Any Other Variable

Also – Discover Why Asset Allocation Alone Can’t Secure Your Portfolio for Life

Choosing a financial advisor who understands the primacy of asset allocation is in the very best interests of every high net worth investor. It takes center stage in the formulation of every customized plan we produce for investors who have $5 million to $500 million in assets.

A well-known study by Brinson, Beebower, and Hood found that over 90% of the variation in your portfolio’s investment performance can be traced to your asset allocation.

To be clear as this study has often been misused on this point, that 90% covers the general allocation classes of equities, bonds, and cash, and does not change much when investment subclasses like mid-cap, small-cap, and international are considered.

high net worth asset allocation

Variations from those classes accounted for less than 10% of the total, and only about 6% of variation came from security selection.

Studies of just about anything rarely conclude that 90% of a thing is caused by one variable. So when they do, everyone ought to pay attention.

In this article, you’re going to see six reasons why asset allocation causes such an outsize effect on your investment performance. But, you’re also going to learn why asset allocation alone isn’t enough.

Everyone loves online calculators, and you can find asset allocation calculators too, such as this one.

Financial Advisor Fremont

But those calculators do not consider the single more important question everyone must answer before they finalize their investment plan. You’ll see what that question is in a bit, and why you must answer it before determining your ideal asset allocation.

First, here are the six reasons why asset allocation affects your long term growth more than any other factor.

  1. Market Volatility Is Unavoidable

A study from Guggenheim Funds studied market behavior dating back to 1946.

They defined a ‘pullback’ as a market reduction between 5-10%. A ‘correction’ was defined as between 10-20%. Lastly, they defined a ‘bear market’ as a reduction of 20% or greater.

This chart reveals what the study observed:

Type of Downturn Number of Incidents Average
Pullbacks 78 1.5 pullbacks per year
Corrections 27 1 correction every 2 years
Bear Markets 11 1 bear market every 7 years

As you might have guessed, the averages don’t tell the whole story. Some years, you don’t have any market downturns at all. Others, you might see several of these all during the same year.

The point is simple:

The market is volatile, and you can’t avoid the effects of that volatility. But you can lose a whole lot more than you should if you work with the wrong financial advisor

For people who believe they can avoid downturns by timing the market, they haven’t studied the data. Here’s a more in-depth exploration of the failures of market timing.

The most shocking revelation in that exploration comes from a study finding that investors who missed just the 10 top performing months over the 30-year period from 1988 to 2017 would have earned less than half what they would have made had they just ridden all the ups and downs during those volatile years (which included 3 recessions, 2 market bubbles).

Other studies have even narrowed it down to a handful of specific days, not months, that produce similarly staggering losses if you missed them.

Since you can’t time the market, a healthy asset allocation is your best weapon for optimizing your performance against market volatility.

If you’re looking for a wealth management team that knows how to ride out market cycles, reach out to Pillar to start the conversation. We’ve seen the ups and downs of the market over the past thirty years and can guide you in the right direction.

  1. Market Volatility Is Unpredictable

No one can predict market performance down to specific months or days, and that’s what it would take to successfully time the market and outperform the investors just riding it out.

Market volatility happens, and you can’t avoid it unless you want to miss out on the biggest possible gains too. In that case, you might as well just park it all in a money market or CD.

Only an optimized asset allocation can protect you from the always volatile market, which fluctuates far more often than the larger economy.

Why is this true?

Because the market’s volatility causes equities to rise and fall in value. And while bonds also change in value, they don’t fluctuate nearly as much, and thus act as a stabilizer against the roller coaster stock market.

Even more stable, though with much smaller gains, is cash, which includes treasury bills, money markets, certificates of deposit, and higher-yield savings accounts.

Therefore, an optimized asset allocation that includes equities, bonds, and cash protects your wealth from the volatile stock market while still earning you the highest possible gains for your risk tolerance.

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  1. Optimized Asset Allocation Balances Higher Growth with Smaller Losses

When the market and many equities lose value from a pullback, a correction, or a bear market, the equities portion of your investments will likely lose value too. But with the right mix of bonds and cash in the mix, you can successfully ride out the storm without your portfolio suffering the steeper losses.

Market volatility’s best friends are anxiety and worry, and you can keep those out of your life with an optimized asset allocation. An even more complete allocation, especially for high net worth investors, also often includes real estate investments.

But the flip side is also true. While an optimized asset allocation protects you from losses, it also secures you the strong growth you need to reach your financial and lifestyle goals and attain financial serenity. Pillar Wealth Management’s customized plans achieve this serenity for our clients. See how we would do this for you. 

Cash always increases in value, albeit at low numbers that may or may not keep up with inflation.

Bonds exist in several varieties, some with more risk than others. But in general, bonds tend to increase in value most of the time. When they do lose value, the losses tend to be small.

Equities have the highest potential for extreme growth. So when your equities are doing well, you still have your cash and bonds working for you in the background.

When your equities struggle in a pullback, correction, or bear market, your cash and bonds keep your overall portfolio stable. For more ways to protect your ultra-high net worth portfolio, check out this free hardcover book.

And again, real estate can provide an additional measure of stability.

  1. Asset Allocation Takes Advantage of Time

When it comes to investing, time is your single greatest resource.

Even for high net worth retirees in their 60s or early 70s, an optimized asset allocation protects you in these critical years when your focus shifts to making your money last throughout your life.

But for investors in their 40s and 50s, an optimized asset allocation helps ensure the long term growth and performance you need to reach all your lifestyle and financial goals.

You’ll weather the short-term storms, and grow during the boom years. Over 10, 20, and 30-year periods, you’ll gain much more than you’ll lose when you prioritize your asset allocation.

  1. Asset Allocation Can Be Adjusted as Life Changes

As a high net worth investor in your 40s, you will likely have a different asset allocation than you will in your 60s. However, especially for high net worth families, this commonly espoused tenet isn’t quite as simple as the asset allocation calculators we mentioned earlier want you to believe.

We’ll get to why in a bit.

But one of the great benefits of using an investment strategy based on asset allocation as opposed to diversification or some other strategy is that you can easily adjust it. You might be in 60% equities, 30% bonds, and 10% cash at one time in your life.

As your life situation adjusts, your financial advisor may recommend shifting these percentages around a bit. As you age, this will happen continually. If your financial advisor doesn’t suggest adjustments as you age, you may want to consider a change. Remember, part of choosing a good financial advisor is finding somebody who adapts to your life changes.

But diversification doesn’t protect you, because diversification can mean so many things. If you’re invested in 100 different equities, you are diversified. But if all those equities fall into just one or two market sectors, your portfolio remains at high risk.

And if you have nothing in bonds or cash but are invested in 1000 equities, when the market tumbles, you won’t escape the damage.

  1. Asset Allocation Can Be Preserved

Once you’ve settled on your optimized allocation for this stage of life, you can easily preserve it through rebalancing. Rebalancing paired with asset allocation are the keys to maintaining the long term security of your portfolio.

The bottom line is this:

Your asset allocation is not something you can just set and forget. It must change in accordance with your life situation, and must be preserved by regular rebalancing (we do this four times per year for our high net worth clients).

Either you need to do it, or you need someone else to do it for you. Either way, someone needs to keep your allocation optimized and on track.

It’s like an airplane flying from San Francisco to Tokyo. In general, this is easy. Fly west. But the farther west you go, the more adjustments and fine-tuning the pilot must make in order to stay on track and actually land on the correct runway.

Avoid making the right adjustments, and you’ll end up in Seoul or Beijing. Or the ocean when you run out of fuel, the equivalent of running out of money before you die.

Maintaining your optimized asset allocation doesn’t require large scale changes, unless your life experiences major financial events, such as unexpected medical events  for you or your relatives.

Barring those types of events, it requires periodic and ongoing adjustments, just like the pilot consistently performs while the passengers sleep, oblivious to his or her flight expertise and experience.

This is why we call it wealth management, as opposed to wealth creation. You don’t just do it once. It’s not set it and forget it.

Again, you can either do this yourself or pay someone else (the pilot who knows how to fly a plane) to do it. But someone has to do it.

If you want to see what a high net worth portfolio plan and your ideal customized asset allocation look like, schedule a Wealth Management Analysis meeting with one of our two high net worth wealth managers.

The Shortfalls of Asset Allocation Calculators and Formulas

Online calculators like the one given at the start of this article try to apply standardized formulas to individual lives based on pre-defined “risk tolerances.” They are inherently non-customized.

A “moderate” investor should use this allocation, an “aggressive” investor should use that one, and the “conservative” investor should use this one, they say.

The problem with this approach is it starts at the wrong place.

The first step to developing an investment plan is not to determine your risk tolerance.

On the contrary, your risk tolerance – and your resulting personalized and non-formulaic asset allocation – depend entirely on your unique life situation, long term lifestyle and financial goals, and current financial status.

As a high net worth or ultra-high net worth investor, your situation is unlike the vast majority of people, including most of the ones using those formulas and calculators. You do NOT fit into those boxes.

    • How much do you want to leave to your heirs?
    • How will future tax law changes affect your plan?
    • How much life insurance, if any, do you need or want?
    • Do you have philanthropic goals during and before retirement?
    • What are your leisure and entertainment plans and preferences?
    • If you become physically incapacitated, will you be more than adequately provided for?
    • Do you spend time doing what you really want to do?

Average investors don’t have to think about these questions in the same way as you, if at all.

You have choices. You have options.

And the choices and options you select – those determine your risk tolerance and the appropriate asset allocation for you as an individual.

Everything you’ve read here about asset allocation is accurate. It is the most fundamental component to an optimized financial plan.

David Swenson, who took the Yale endowment portfolio from $1 billion to $23 billion through recessions and wars, says that asset allocation is the most important investment decision of your lifetime. This is the consensus among almost all financial professionals, as this article makes clear.

The question is, what asset allocation is right for you?

To find out, schedule a free Wealth Management Analysis meeting. You have nothing to lose by starting a no-strings-attached conversation with our experienced team.

Financial Advisor Walnut Creek