In Don Phillips’ article “The Things You Can Control ” he suggests that the best advisors help their clients focus on what can be controlled and not fret about the the rest even when when uncontrollable things are what clients think are the most important. His third suggestion is to:

3. Use a goals-based asset allocation. Once you commit clients to saving, it’s essential to make prudent investment allocations. Market forecasters center on which stock to pick or which sector to bet big on. Smart advisors ignore all of that, instead focusing on the facts as they know about their clients and their goals. I recall one top advisor laughing at a seller of asset-allocation software who made the case that a 25-year-old’s asset allocation needs to be a function of career choice, risk tolerance, and current market valuations. The advisor responded, “I’m telling any working 25-year-old to be 100% in stocks for their retirement, regardless of their career choice, market expectations, or risk tolerance.” Asset allocation should be linked to what you can control (the client), not what you can’t (the market).

Trying to time the market is a losing proposition. Market tides are not predictable and it is better to simply swim well. Watching the markets focuses people unnecessarily on short-term returns when the long-term is more important. Market timers are likely to see patterns that don’t exist and trick themselves into selling low and buying high, assuming that whatever a security has done recently will be what it continues to do. They only manage to accomplish the exact opposite of what they intend: selling high and buying low. Instead, we teach our clients to ignore the daily financial noise and to not continually look at short-term investment returns.

We have written on “The Complete Guide to Creating an Investment Plan” and, specifically, how your allocation to bonds is dependent on your expected withdrawal rate not risk tolerance. For the average investor, their risk-return mix should lean heavily toward stocks so that their portfolio can keep up with inflation. The bond allocation of the portfolio should be able to fund 5-7 years of safe spending, neither more nor less.

What Phillips makes clear is that considerations other than the withdrawal rate should not influence your asset allocation.

You should not put 40% or 50% in bonds just to “play it safe” if putting 25% in bonds gives you a better chance of not outliving your money. Putting more money in bonds or cash is not necessarily “playing it safe.” Inflation is at least as important a consideration as stock market volatility.

You should not put more money in bonds just because you have a low risk tolerance. Neither should you put more money in stocks because you have a high risk tolerance. Two people in the exact same financial situation who need to support the exact same withdrawals within the exact same time horizon should have very similar asset allocations. There is an optimum asset allocation which provides the best chance of meeting their similar goals. How each investor feels does not change the optimum asset allocation.

An advisor’s job is to recommend the optimum asset allocation regardless of how the client might answer a survey about risk tolerance. A client’s emotions are only important because they can lead the client to chase returns or to give up on an investment plan at the wrong moment.

To the extent that a client is living well within their means, they are able to stray from an optimum asset allocation and still have a strong chance of meeting their financial goals. If they have more money than they will likely need then they can be more aggressive or conservative than the optimum asset allocation. They can move more conservative because even if their money does not keep up with inflation they will still have enough to meet their goals. They can move more aggressive because even if the markets are volatile they will still have enough to meet their goals. But although they do not need to have the optimum asset allocation in order to meet their goals, the optimum asset allocation is still optimal, and so is what a good advisor should recommend.

The mathematics of asset allocation are more important than a client’s feelings about investment. A client’s goals are what matter and there is a best way to meet any given set of goals. That is what forms a good asset allocation.

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