The Curious Investor

The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk written by Dr. William Bernstein is a must read for anyone looking to take control of their own finances. It provides valuable details and insight into topics regarding risk management, indexing, and, obviously, asset allocation. Bernstein is a self-taught investment guru who’s aim has always been to bring to light the mysterious statistics and portfolio management strategies that professional fund managers employ. While the book assumes a bit of general statistics background, it is written in a very practical and easy to understand manner. His examples do a terrific job illustrating points on risk and return scenarios as well as clarifying a subject which, to most people, is rather foreign.

Choosing an asset allocation may be the single most important investment decision that an investor can make. More often than not, proper asset allocation is the key to predictable, long-term gains at manageable risk levels. This book covers all of the fundamentals of how asset allocations are built from the analysis of historical returns and does a terrific job of illuminating what exactly the almighty efficient frontier is. (Word to the wise, if your financial planner or investment manager claims that your portfolio is on the efficient frontier, it’s time to find a new one.)

There were, however, a few things about this book that I felt were lacking. It seems from Bernstein’s own admission in the newest edition of this book that he has removed some of the more meaty sections on doing risk-return calculations for example Mean Variance Optimization. Instead, he references some programs which are available (for a price) that will do it for you. Granted, MVO is not something that one could quickly and simply build an excel spreadsheet to do, but it would have been nice to have a little bit more discussion on a topic that is likely the most important to anyone wanting to gain capability in doing asset allocation analyses on their own.

The book also does not go into much detail on how one can find the historical returns data necessary to carry out asset allocation calculations. It references a few dated web sources, but ultimately falls a bit short of providing all the necessary tools to continue to carry out the book’s lessons in real life. As the book’s latest edition is from around 2000, it is a little bit frustrating.  While seven years of returns may not change allocations that much and Bernstein’s own model allocations are probably good enough for anyone wanting to apply the strategies he discusses, it would be nice to have the tools to confirm his conclusions on your own using more recent data. That being said, Bernstein does operate a website which features a lot of more up to date companion information, http://efficientfrontier.com. It’s ugly (maybe he should hire me to do a facelift!) but it is a good repository for further information though, again, most of it is not free.

Now, for those interested in actively managing their stock portfolios, The Intelligent Asset Allocator may not be for them. After all, it stresses indexing for returns as opposed to how to identify individual stocks for high returns. I’ve been trying to think of how to apply this book’s strategies to a more concentrated, actively managed portfolio and have quickly realized that the two approaches to investing are mutually exclusive. Asset allocation depends on predictable long-term volatility (hence the focus on indexing) while the “pick and pray” investing that most investors participate in depends on a stock behaving differently from how it did before (preferably to the upside) over a shorter time period.

Obviously, as I’m young and hoping to really build up my net worth, I’ll likely continue to build concentrated stock portfolios in hopes of striking it big. That being said, there will come a point in my life when it will be time to take a more conservative approach to my investments. An approach which I can count on for predictable returns to retire on. If you’re already there in your life, you’re likely better off picking up this book and spending your time devising a strong asset allocation mix than trying to find the next Microsoft to dump all of your money into.

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