Top-Down Investment Process: 70% Asset Allocation


In our experience, the biggest driver of long-term investing success and meeting your retirement goals is asset allocation. Asset allocation is the selection of stocks, bonds, cash or other securities that make up your investment portfolio.

We view asset allocation as a primary and preliminary step that lays the groundwork for additional steps. These include individual equity selection and broader style selection (e.g., sector selection, market capitalization, etc.). Before diving into those details of stock selection or style selection, it is critical to select an appropriate allocation that helps increase the likelihood of meeting your goals and needs.

The Role of Asset Allocation

The first step in investing should be to identify your goals, then you can decide which long-term asset allocation is best suited to help you achieve those goals. Some asset managers may select assets based on a single factor like risk tolerance, or recommend a one-size-fits-all strategy based only on age or retirement date, similar to target date mutual funds. However, we believe that individual investors—even if the same age—may have different needs or goals that may require a different asset allocation. We begin with determining the right asset allocation for an investor’s personal situation and goals by learning about them, their family, their cash flow needs and much more. We believe this step in determining the most appropriate asset classes and allocations for your needs is critical for achieving long-term success.

Along with your long-term asset allocation, we consider a tactical asset allocation—one based on our forward-looking market forecasts. We take a top-down investment approach when making these portfolio decisions and consider economic, political and sentiment factors driving markets., We then move on to category decisions and finally to selecting individual securities. It is important to begin with the appropriate long-term asset allocation for your needs—but also important to be able to tactically change asset allocations based on market conditions to help enhance your chances of reaching your investment goals.

The 70/20/10 Funnel

The funnel in Exhibit 1 illustrates how we organize the various fundamental factors and processes that go into making important investment decisions.

Exhibit 1: The 70/20/10 Funnel

*Forward-looking return attributions is an approximation intended for illustrative purposes and should not be considered a forecast of future returns or return attribution.

  • Asset Allocation—We believe approximately 70% of a portfolio’s return can be attributed to asset allocation. This selection process covers a mix of asset classes such as equities, bonds, cash and other securities in your portfolio, all of which we determine by broadly analyzing fundamentally driven factors. Selecting the appropriate asset allocation depends on an investor’s personal situation, needs and goals—we do not use any one rule of thumb to select an asset class mix. Instead, we carefully consider a variety of factors including your personal time horizon, cash flow considerations and asset goals.
  • Sub-Asset Allocation—We believe approximately 20% of a portfolio’s returns can be attributed to sub-asset allocation selection. This includes selecting from categories of sector, country, market capitalization, valuation and other factors.
  • Individual Stock Selection—We believe selection of specific equities, bonds and other securities contributes about 10% to a portfolio’s returns.

In our investing approach, we place the greatest emphasis on asset allocation. We believe its contribution to portfolio returns outweighs those of the remaining two categories.

Risks When Choosing an Asset Allocation Strategy

If a majority of your potential returns rests on how you select asset classes within your portfolio, there is a lot at stake when it comes to this allocation decision. Naturally, on the other side of the benefits of asset allocation are the risks you face should you allocate improperly.

There are several risks of improper asset allocation. First, you could fall short of your goals if you opt for an overly conservative portfolio and have not planned for enough long-term portfolio growth. Similarly, an improperly allocated investment could also prevent you from maintaining the standard of living you may have envisioned for your retirement—especially if you have overlooked the potential impact of inflation on your money.

Many investors have planned to enjoy their retirement years and have worked hard to accrue assets to support this retirement lifestyle. Fear of losses may lead some investors to avoid short-term volatility, thinking it too risky. However, investing too conservatively carries significant risk as well. A financial adviser may be able to help you find the best approach for your individual situation.

Tactical Asset Allocation Strategies: Time in the Market vs. Timing the Market

Do you expect equities to rise in the near future, or do you believe a bear market is lurking on the horizon? What asset allocation strategies can you use during different market cycles?

During a bear market, using your analysis of macroeconomic data and market drivers (political, economic and sentiment) may help you make tactical asset allocation decisions to preserve more of your portfolio during a major downturn. But, herein lies a critical caveat: When considering allocation strategies, remember that investment returns have more to do with time in the market than with timing the market. For this reason, having a professional money manager or adviser can help investors avoid making critical investing mistakes.

Too often, investors risk hurting their long-term returns and falling short of their goals because they make ill-timed, emotional trades. Some common examples are selling stocks because the market is falling or purchasing securities in a “hot” sector to chase returns. Both of these examples can hurt investor’s returns. For example, if you sold your securities during a market downturn, you may risk missing the subsequent rebound, which can mean you sold low and had to buy high on your way back in the market. Chasing the returns of a hot sector can similarly hurt your portfolio if you purchase a sector that has been outperforming only to watch it underperform moving forward.

Risks of Timing Stock Market Cycles

It may be possible to anticipate or identify new market cycles based on forward-looking fundamental data. But the reality is nobody can perfectlypinpointthe onset of a bull (rising) or bear (falling) market. Market cycles can be extremely difficult for investors to identify. Economic drivers are in constant flux and changes can be inconspicuous and incremental or sudden and massive. Sorting out economic fact from fiction can also be difficult, particularly if your main source of information is widely available financial media.

Moreover, finding time to research the markets and understand what is happening can be difficult. Not everyone has the time, resources or knowledge to conduct a market analysis. There are also risks from emotional decision-making, such as reacting to short-term market volatility out of fear, when attempting to time market cycles as an investor—risks that could hurt your returns in the long run.

Even the savviest and most experienced investor can fall prey to making emotional investment decisions, particularly during periods of significant stock market volatility. This is why working with a trusted investment adviser on long-term and tactical asset allocations can be helpful in shaping your allocation strategy to match your retirement goals.

Benefits of Working with an Investment Adviser

A trusted investment adviser like Fisher Investments can help you identify how to properly allocate your assets. One of your adviser’s most important first steps should be to evaluate the appropriateness of your longer-term asset allocation relative to your goals. Having an investment adviser take on the heavy lifting of research and asset allocation management can be a real convenience, as it gives you the time to focus on everything else in your life.

Our asset allocation management process begins with getting to know your personal and financial goals. Your dedicated Investment Counselor will work with you to identify your goals, investment time horizon and other factors relevant to constructing an asset allocation strategy. Give Fisher Investments a call today at 1 (888) 823-9566 and find out more about our top-down investment process.

Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns. Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations.