I Will Teach You To Be Rich: No guilt, no excuses - just a 6-week programme that works

by Ramit Sethi

Anyway, the little-known fact is that the major predictor of your portfolio’s volatility doesn’t stem from the individual stocks you pick, as most people think, but instead from your mix of stocks and bonds. In 1986, researchers Gary Brinson, Randolph Hood, and Gilbert Beebower published a study in Financial Analysts Journal that rocked the financial world. They demonstrated that more than 90% of your portfolio’s volatility is a result of your asset allocation. I know “asset allocation” sounds like a BS phrase – like “mission statement” or “strategic alliance”. But it’s not. Asset allocation is your plan for investing, the way you distribute the investments in your portfolio between stocks, bonds and cash. In other words, by diversifying your investments across different asset classes (like stocks and bonds or, better yet, stock funds and bond funds), you can control the risk in your portfolio – and therefore control how much money, on average, you’ll lose due to volatility. It turns out that the way you allocate your portfolio – whether it’s 100% stocks or 90% stocks and 10% bonds – makes a profound difference on your returns. (Later, other researchers tried to measure how closely volatility and returns were correlated, but the answer ends up being pretty complicated.) Suffice it to say that asset allocation is the most significant part of your portfolio that you can control.