Pre-Retirement Asset Allocation

by: SA For FAs

Ben Inker: Investors focus on their portfolios to the detriment of their larger objectives.

Kevin Wilson: Major corporations are undermining the competitive aspects of “capitalism.”.

Thought For The Day: It’s the person, not the portfolio, that matters most in investment decision making.

Is The U.S. Still Capitalist?

“It is not at all clear that what we see now in our economy is actually what one might truthfully describe as ‘capitalism.’ Major corporations often successfully seek monopoly power, engage in price fixing, curtail competition, and otherwise engage in the defeat of the competitive aspects of ‘capitalism.’” (Kevin Wilson)


“Brazilian assets have underperformed the broad emerging market index this year, despite signs that economic growth is accelerating and earnings prospects remain intact. Instead, investors are focused on the negotiations around pension reform. We expect volatility around the negotiations to continue until reform is enacted.” (Christopher Dhanraj)

Proper Asset Allocation

“Investors have a tendency to focus on the characteristics of their portfolios almost to the exclusion of other factors that will lead to success or failure for the larger objective that the portfolio is intended to serve. By taking into account the characteristics of the assets and liabilities that exist outside of their investment portfolios, they could build portfolios that are a better match for the true problem they should be solving.” (Ben Inker, GMO Q1 Quarterly Letter)

Thought For The Day

Famed institutional fund manager GMO put out its quarterly letter, featuring discussion of asset allocation that is quite atypical of this genre. Asset allocation is widely believed by investment theorists to have a greater influence on portfolio outcomes than specific stock picks, so it’s a shame we don’t hear more on this topic. Also striking, the letter’s author, Ben Inker, who heads GMO’s Asset Allocation team (a nice touch for an investment firm), offers a nonconventional view, but I think a correct one. As the quote above indicates, Inker argues that investors are overfocussed on the contents of their portfolios to the detriment of their overall portfolio objectives.

To illustrate this point, Inker offers a hypothetical case of three investors, each needing to accumulate 10 times their salaries for retirement, each saving 10% of their income, each seeing the same income growth over their careers, each with the same risk tolerance and therefore the identical allocation between stocks and bonds. Where they differ is that one is a teacher, one works in manufacturing and the other in financial services. What he’s setting up here is a scenario in which our three workers have different exposure to the negative shock of a financial crisis. The financial exec may make more money than the teacher, but the teacher’s services are likely needed throughout the period of financial crisis, whereas the finance exec may be out of work for years. Here’s how Inker sums up the matter:

If we assume a strong covariance between labor income and stock returns, such as might be the case for a worker in the financial services industry, we get the interesting result that workers in their 40s or older should have less in stocks than they should at retirement. While this runs counter to the standard advice and most traditional retirement glide paths, it does make plenty of sense when you think about how a depression impacts someone who is relatively close to retirement versus someone who has already retired.”

Ironically, it is the very folks who (usually correctly) counsel risk-taking in investing via greater stock ownership (rather than, say, safe CDs) who themselves cannot afford that much risk, because of this “covariance” of which Inker speaks.

And so it goes for all investors, each according to his individual circumstances. As a wise advisor once put it to me, “the person is the focus of attention, not the portfolio.” This idea is also discussed in Moshe Milevsky’s classic work, “Are You A Stock Or A Bond?” which explains the value of a conservative investing style for people with volatile incomes and, contrarily, an aggressive allocation for those with bond-like income.

And thus investors putting together a portfolio for retirement would do well to return to these basics and develop a risk budget that fits their individual circumstances before wasting time on the weeds of that portfolio’s individual constituents. Otherwise, even an aggressive portfolio with high expected return may simply not comport with the lifecycle needs of an investor who requires a financial stability that counterbalances a volatile career. It’s about “smoothing” income, as the economists express this idea, and an excellent reason for paying more attention to asset allocation.


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