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The Importance of Asset Allocation

When most people think about investing, the first thing that comes to mind is usually a Wall Street stock broker. It is interesting that all of the attention in the investment management industry goes to individuals who focus on security selection (i.e., stock picking). Yet academic research has shown that asset allocation is more important than security selection in determining investment portfolio returns. In other words, it is more important to my long-term returns that my portfolio is 80% stocks and 20% bonds (instead of 50% stocks and 50% bonds) than which individual stocks make up that 80%.

So why does asset allocation get short shrift? I think because it involves fewer choices and is less tangible. Security selection (stock picking) offers thousands of choices and is more concrete. Many individual investors will spend hours and hours reading and researching individual companies, expecting the time and effort they put in will be rewarded with higher returns. I spend more time focused on asset allocation.

The asset allocation decision is the point of greatest leverage that we have over our investment portfolio and its long-term expected returns.

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