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Protecting Your Wealth in Good Times and Bad Chapter 12

Chapter 12 Asset Allocation Explained. “Asset allocation” is an old buzzword among large pension plans. The idea of not putting all your eggs in one basket is widely followed by those responsible for managing defined benefit pension plans for millions of workers. | chapter 12 Asset Allocation Explained To invest successfully over a lifetime does not require a stratospheric IQ unusual business insights or inside information. What s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. Warren Buffett A . L Vsset allocation is an old buzzword among large pension plans. The idea of not putting all your eggs in one basket is widely followed by those responsible for managing defined benefit pension plans for millions of workers. Unfortunately the lesson of diversification was an expensive one for millions of individual investors who saw their retirement portfolios hammered in the last bear market. For most people under the age of 50 the recent bear market was the first taste of what can happen if you get greedy. Those over 50 were reminded of what risk is. The aggressive investments that Wall Street is typically fanatical about selling finally took a back seat to prudence as most surviving stockbrokers switched hats and started talking about risk reduction asset allocation and long-term investing. Prior to the 1970s the mathematical models used to help Copyirght 2003 by The McGraw-Hill Companies Inc. Click Here for Terms of Use. 185 Protecting Your Wealth in Good Times and Bad make asset allocation decisions were foreign to all but a few academic researchers and large pension fund managers. The traditional view of diversification was simply to avoid putting all your money in one place. That meant owning a few bonds in your stock portfolio. But in 1952 Harry Markowitz a 25-year-old graduate student from the University of Chicago wrote a revolutionary research paper titled Portfolio Selection that changed the way people thought about their investment portfolios. In short Markowitz discussed the idea that financial risk is necessary in a portfolio to achieve a higher rate of return but that risk can be reduced through proper diversification of investments. Since