Biorhythms Shows Flaws in Asset Allocation and Diversification

It occurred to me that yet again we tend to assume as fact thing we are told often enough. This is very true about asset allocation and diversification sold to you as a way to protect your nest egg when investing over the long term.

If you ask most any Baby Boomer about how to protect their nest egg they will almost certainly tell you your nest egg needs to be diversified and properly allocated. It’s now built-in to your belief system and is often said without any thought as to its validity.

I want to use biorhythm charts to point out what I thing is a major flaw with asset allocation and diversification as used in a buy and hold strategy.

Biorhythm Charts demonstrate this phenomenon very simply with the cycles used to plot your well-being. As you probably know there are the physical – 23 days, emotional – 28 days and intellectual – 33 days cycles.Biorhythms are a good analogy for asset cycles

When they all sync together at the low of the chart you don’t have much energy, you may feel down and you might not be able to concentrate. At least that is what they claim.

Go ahead have a play with the Biorhythms and plot your own chart. Then click the Prev and Next buttons to look for cycles that coincide. Then read the rest of this post and see if you agree with me. Comments are most welcome.

You might even consider following your biorhythms chart for a while to see if it really works.

The free biorhythm charts available at Cycle Tourist are some of the best I have seen. They also include a unique Critical Days Map to let you know which days you need to be concerned about.

What has this got to do with investing?

Well, we are often told that markets are cyclical and we need to have proper asset allocation and be fully diversified to ensure we protect our nest egg from the down-side.

Wealth managers will tell you that the idea of diversification is to have some of your money in assets that are going up in value when other assets are going down. Over the long run this should protect your nest egg and ensure it grows.

Let’s take a simple case of using the three cycles in Biorhythms to represent three of the main assets wealth managers use to invest your money into.

Let’s say the physical (blue) is equities, the emotional (red) is property and the intellectual (green) is fixed interest.

Take a look at the chart above. For about 5 days in January 2010 all three are going to be at their lows.

If they do represent your diversified portfolio where is the protection you were  promised? It rarely happens over the long term but if you just happen to be about to retire you have a disaster on your hands. You may have lost 50% of your nest egg or more just because all the cycles were at their lowest at the same time. (later on in the chart they are in sync again for what might be extraordinary returns. This can happen too). But it is the down-side you need to worry about in retirement – avoid large losses.)

This chart shows days for biorhythms but it could easily be months for your investments and the cycles will not be as regular as these are. The amplitude could represent the returns and so you can also expect that to vary as well.

I saw this phenomenon at one point in my own managed funds. The investments were not at the lows but most of them were negative, with some going into negative and others coming out of negative cycles. That’s one reason I redeemed my money. Although I had no simple explanation then of how this could happen.

Also my financial advisers failed to respond properly to my concerns about how they would protect my nest egg in the event of a major market crash. Their only answer was that this is normal every 5-7 years, and I just need to stick to the plan.

The other “reassuring” thing they said was that in a properly diversified and allocated portfolio the losses should be minimised because all assets do not move in sync with each other. Some would compensate for the others.

It is only now that I have realised that may be true some of the time. But they do not move within the same cyclic period. I think we all agree the economy and the stock market move in cycles. The unstated assumption seems to be those cycles have the same frequency so as one market is going down an other is coming up.

They therefore claim by allocating your nest egg funds across the assets you should be protected from significant losses and this partly justifies their asset allocation model and a buy and hold strategy.

Well in my mind that is just not true. I’ll accept that markets do move in cycles but the periodicity of those markets can be very different for a variety of reasons. The frequency of the cycles can also vary both in the full cycle and within a single cycle.

In other words a cycle for stocks might start with bull phase and peak in 3 months but the down cycle might only take one month (bull markets are escalators and bear markets are lifts for the stock market). That is an asymmetric cycle as the periodicity changes over the cycle. You wont know.

Now lets say a cycle for property starts a new bull  after the bull in the stocks but it takes 6 months to peak. Maybe it then takes 12 months to come down again. This may be due to property being a harder asset to liquidate.

At some point in time these asymmetric cycles can coincide. If it is at the high that’s great. Take the profit and stand aside. If it is at the lows you are in serious trouble.

As I stated earlier if we could chart the cycles for equities, property and fixed interest and cash, the only assets most wealth managers will invest your money into, there will be times when they are all in sync.

When that happens your nest egg could be devastated and it will hurt if it just happens to be the time you intend to retire and live off that money.

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