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Stock Pickers, Market Timers, and Crystal Balls

“The worst months to invest money in the stock market are October, January, and May. The others are February, June, November, March, August, April, September, July, and December.

Mark Twain’s sense of humor is reflected in his quote on investing – unfortunately, his investing experience was far from humorous. While his writing was very profitable, he lost a great deal of money as a result of his attempts at market timing and security selection. His initial foray into investing resulted in bankruptcy.

The experience of most investors is like Mark Twain’s; though hopefully, not resulting in bankruptcy. Historically, of all the asset classes, stocks have provided the highest returns. The average return for the S&P 500 (dividends included) is 11.96% (1928 – 2020).

The problem for investors – and our dear friend Mark – is the human predilection for “picking a winner.” To my knowledge, no one is able to see into the future and the concept of picking a winner is a myth.

So, how do you invest without picking a winner? The answer is Asset Allocation. 

Asset Allocation is the process of allocating investment dollars among different asset classes, such as stocks, bonds, and cash. Each investor is unique and the process of determining which mix of assets to hold in an investment portfolio is based on a variety of facts and circumstances applicable to that investor.

Facts and circumstances include the investor’s time horizon and their ability to tolerate risk (the ups and downs in the market). An individual planning to be financially independent in 10 years will certainly have a different asset allocation than someone who is 20 years from financial independence. Insurance coverage and emergency reserves also impact asset allocation. If an investor has sufficiently insured against the various risks managed by insurance (life, disability, property and casualty), then they are able to accept more risk in their asset allocation.

Gary P. Brinson, Randolph Hood, and Gilbert L. Beebower studied the effects of asset allocation on investment returns. Their paper is called the “Determinants of Portfolio Performance.” They discovered that 91.5% of an investor’s annual return is the result of asset allocation and not security selection and market timing. Unfortunately, the study arrived about 100 years too late to help Mr. Twain.