Should you try asset allocation yourself?

Investing chart on paper
  • Fund companies market the 4,000 asset allocation funds under different labels.
  • Asset allocation should be kept uppermost in mind when designing a portfolio.
  • Rebalancing periodically usually gives a portfolio a buy-low/sell-high bias.

Investors face a growing number of options when choosing an asset allocation plan to power their investment portfolios.

Nearly 4,000 mutual funds and ETFs specialize in managing asset allocation in one form or another, and more than a dozen new ones launched in this year's first quarter alone, according to Morningstar. The products are marketed under several labels, including asset allocation fund, balanced fund or the current favorite: target-date fund. By contrast, most other funds target specific asset classes -- U.S. equities or foreign bonds, for example. Many specialize in subsets such as domestic small-cap value stocks or real estate investment trusts.

Investors or their financial advisers should keep asset allocation uppermost in mind when designing a portfolio. The first question to answer is whether to use several funds, each focused on a single asset class, or one asset allocation fund that offers a mix of asset classes. If you opt for an asset allocation fund, the strategy should match your financial goals.

"Asset allocation should be individually designed for each individual," says Richard Ferri, founder of Portfolio Solutions, based in Troy, Mich., and author of several investment books, including "All About Asset Allocation."

The importance of asset allocation

The stakes are high. Numerous studies over the years advise that asset allocation is a critical investment decision. Roughly 90 percent of a portfolio's long-term investment performance is linked with the broad asset mix, research shows.

"The most important thing you can do to achieve success in investing is to get your portfolio's asset allocation mix right and stick with it," says Jerry Miccolis, chief investment officer of Brinton Eaton Wealth Advisors and co-author of "Asset Allocation For Dummies."

Keeping the mix in sync with investment goals is a challenge for fund managers and do-it-yourselfers alike. Many studies show that keeping asset allocation from straying too far from the portfolio's target mix can increase performance in the long run.

For example, consider a portfolio that's set to 60 percent stocks and 40 percent bonds at the close of 2000. Suppose, too, that the equity allocation is equally divided between U.S. and foreign stocks. One version of the strategy is unmanaged, allowed to run without intervention. The other portfolio is identical initially, except that every Dec. 31 it is rebalanced to maintain the original 60/40 mix.

The rebalancing bonus
Each balanced portfolio is set to 60/40 stock-bond weights on Dec. 31, 2000. One is unmanaged. The rebalanced strategy resets weights back to initial asset allocation every Dec. 31.
Asset allocation comparison
Each strategy is initially structured with 30 percent U.S. stocks (Russell 3000), 30 percent foreign stocks (MSCI EAFE) and 40 percent U.S. bonds (Barclays Aggregate Bond).
Source: Jim Picerno, using Morningstar Principia software

As shown in the accompanying chart, the rebalanced strategy performs better for the decade through the end of 2010, returning 4.9 percent per year, compared to 4.1 percent for the portfolio that's not rebalanced.

Buying low, selling high

Rebalancing a broadly diversified portfolio across several asset classes "provides the investor with an automatic buy-low, sell-high bias that over the long run usually -- but not always -- improves returns," writes financial planner William Bernstein in "The Investor's Manifesto."


Most asset allocation mutual funds rebalance. The details can vary widely. And because funds are managed for large groups of people, an individual investor's needs may not be met.


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