Bad Practices

Jahnke, William
September 2003
Journal of Financial Planning;Sep2003, Vol. 16 Issue 9, p26
Academic Journal
This article focuses on the establishment of an asset allocation policy doctrine in the financial planning community in the 1990s. Apparently, many investment practices are based on the beliefs that markets are macro-efficient and that historical returns provide a reasonable basis for estimating future returns. Given this and the Brinson studies' finding that asset allocation policy determines over 90 percent of portfolio performance and market timing fails to add value, and given a large historical equity risk premium, the doctrine took root in the financial planning community. According to the doctrine, investors should allocate as much to stocks as their tolerance for short-term volatility permits, and to stay the course regardless of investment performance unless the client's circumstances change. Unfortunately, all of the assumptions underpinning the asset allocation policy doctrine are false and the acceptance of the doctrine supports a number of bad practices. The pricing of asset classes does not operate in accordance with efficient market theory and equity returns are not governed by a stable return-generating process in which the time series of stock market returns exhibits fat tails, short-term serial correlation and intermediate-tern mean reversion.


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