The Intelligent Asset Allocator

Submitted by Book Library on 12 March, 2010 - 15:40

Bernstein has become a guru to a peculiarly '90s group: well-educated, Internet powered people intent on investing well and with minimal ‘help' from professional Wall Street. Robert Barker, Business Week William Bernstein is one of today's most unlikely financial heroes. A practicing neurologist, he used his self-taught investment knowledge and research to build a popular investor's website. Now, in the plain spoken The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk he shows independent investors how to build a diversified portfolio--without the help of a financial adviser.

Positive Review of Book

I would have to agree with John Bogle's endorsement: "This is a great book!" While Malkiel's Random Walk covers Modern Portfolio Theory, Bogle covers the virtues of index investing, and Graham, Lynch and Fisher cover individual stock selection, studies show that asset allocation alone is responsible for over 90% of a portfolio's performance in the long run. Yet asset allocation theory seems to me to be under-represented in the investment literature for non-professionals.

Bernstein's book goes a long way to correct this gap. He starts out almost too simply. Bernstein takes the reader step-by-step through a discussion of basic financial math and statistics (hitting variance and correlation coefficients in particular) as he builds the case and explanation behind asset diversification. He writes to an intelligent audience but does not assume a mathematical or financial background.

I like that he encourages the reader to take a chapter at a time. He instructs the reader to finish the chapter, and then put the book down and get back to life. This adds to the methodical tone of the book: a step at a time. In the final chapter "Odds and Ends" the author changes gears. Suddenly we are in the world of - well - odds and ends, the finer points of portfolio management. This was the most interesting part of the book for me. Here Bernstein reviews the case for index investing and - of special interest to me - value investing. What is the premium in returns for small vs. large caps, value vs. growth? Which MPT stat, P/E or P/B is the better predictor of future performance?

Why is value averaging so important and yet so counter intuitive? This chapter alone was worth the price of the book. Finally, Bernstein shares the wealth. The bibliography and recommending reading sections are terrific. This alone might be worth twice the price of the book. In a time when we are all more intimately involved with the management of our retirement accounts, I cannot recommend this book highly enough to anyone and everyone. You cannot afford not to be familiar with the contents of this book. Highly recommended.

Negative Review of Book

I am a programmer and usually do not write financial books reviews. Also it is easy to criticize The Intelligent Asset Allocator which was published 6 years ago (it was published September 22, 2000 when smell of the forthcoming dot-com crash was already in the air). At the time of publication it was a very good book that definitely saved a lot of pensions from complete decimation due to heavy doze of technology-related stocks (or funds), an allocation typical for the level of greed (or appetite for risk taking) that was typical during dot-com bubble.

But now we need to take recommendations more skeptically and at least check how they faired during six years since the book publication before jumping into action. And if we are talking about investment book it is prudent to judge its value on the base of performance of its recommendations in five years or even a decade after the publication.

Thinking about optimizing my 401K portfolio before possible this (or next) year stock slide due to an inverted yield curve I dusted off the book and simulated the performance for one of the recommended portfolios for the period from Jan, 2000 to Mar, 2006. The initial investment was assumed to be zero and monthly contributions assumed to be $1K. Rebalancing was done at the end of each year.

Please be aware that recommended on page 154 portfolio using the period and contribution mentioned above with the end of the year rebalancing produces almost zero return on the capital from Jan 2000 to March 2006 (7% total or ~1% annualized excluding taxes and fees). Taxes and mutual funds fees will drive return lower. For example Vanguard additionally charges annually $10 for any fund in which you have less then $10K. That means that any Vanguard money market fond provides better return with much less risk for this period. BTW without rebalancing the same portfolio produces 31% total or ~5% annualized beating S&P500 (17% total return with the monthly investment of 1K mentioned above). It looks like this "rebalancing-induced returns drop" is the most pronounced when you start with zero initial capital. If the initial capital distributed into the "slots" the first month is comparable to the subsequent investment (say $50K or $100K, while subsequent monthly investment for the period is 76K) "rebalancing-induced returns drop" is less pronounced and is approximately 50% of total return. BTW the book recommended the initial capital for this portfolio in $100K-200K range which helps to avoid some mutual funds fees inherent in splitting small initial capital into 9 slots, so the case above should be viewed as an extreme version of the "rebalancing-induced returns drop".

Unless my calculations are wrong ( I strongly recommend not to take my results for granted; anybody can redo the calculations using Excel; it's not that difficult) it looks like the idea of periodic end of the year "blind" rebalancing that the author preaches is open to review. It would be also interesting to make simulation runs based on the data from 1995 version of his book which permits checking a decade of performance but I do not have it.

Author Biography

William Bernstein, Ph.D., M.D., is a practicing neurologist in Oregon. Known for his quarterly journal of asset allocation and portfolio theory Efficient Frontier, Dr. Bernstein is also a principal in the money management firm Efficient Frontier Advisors, is a frequent guest columnist for Morningstar, and is often quoted in The Wall Street Journal.

Table of Contents

  1. Chapter 1: General Considerations
  2. Chapter 2: Behavior of Single Asset Classes
    • The behavior of domestic and foreign asset classes in this century.
  3. Chapter 3: Theoretical Considerations
    • The behavior of elementary portfolios and the relationships of asset classes.
  4. Chapter 4: Behavior of Real-World Portfolios
    • The role of international and small-cap diversification.
  5. Chapter 5: Optimal Portfolio Allocations
    • How to arrive at an effective asset allocation.
  6. Chapter 6: Market Efficiency
    • Why the market is smarter than you, and everybody else. What to do about it.
  7. Chapter 7: Odds and Ends
    • Value investing: free lunch, or risky business? The "new era," Dow 36,000. Hedging, dynamic allocation. Behavioral finance.
  8. Chapter 8: Implementing Your Asset Allocation
    • How to actually deploy your assets. From fast and simple to highly complex: how to execute the plan.
  9. Chapter 9: Investment Resources
    • In print, and on the Web.

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