Asset Allocation and Diversification is Dead

The wealth managers version of Asset Allocation and portfolio diversification is dead. It was never designed to protect your money in the first place. It was designed to provide a constant stream of income for the fund managers and the financial planners.

Why do you think the banks paid such large sums of money for the once independent large fund managers? In Australia it is a cash cow with compulsory superannuation.  You may recall an Australian bank called Westpac reported earning more from its wealth management arm than from its core banking arm last year.

I have no maths to prove this yet (I’m researching this) but to me the wealth managers version of Asset Allocation and Diversification only works if there is a bull market. The wealth industry has only been going for 25 years. That just happens to be the length of this last major bull market which just ended – maybe.

Only 25 years of data is being used to sell you on the benefit of mutual funds. This is not long term and does not encompass a major bear market with mass public involvement in the stock markets. The mantra is the market always comes back and asset allocation with diversification will minimise the losses during the down years.

But it has not been tested in a long term bear market. We may be about to find out.

With 85% of people being in mutual funds and mutual funds investing in asset classes from which fees can be easily extracted hidden or otherwise, makes no sense if we are going into an extended bear market.

It seems to me if everyone is in the same investments chasing the same returns, the only way they can appear to get returns is if they can bid up the price of those assets on paper and convince investors to never sell them.

I’ll repeat “and never sell them” otherwise known as “Buy and Hold“.

It is only when an asset is sold we really know what it’s market value is. We are now finding out that you can only keep passing the same assets around so many times at higher prices before the whole flawed financial model falls in a heap.

If 85% of us are investing in the same assets who do we sell to when the market turns and a large number of us want to get out quickly?

At the very least even if the there is a bull market Baby Boomers will gradually increase their redemptions as pensions. The days of mass accumulation of funds under management may well be numbered.

I’m sure the funds have statistics on markets like this one that tell them how many of their clients will capitulate and ask to redeem their money.

They still have the last laugh on your money though because they can stop redemptions if the fund is in financial strife. The martial law of “buy and hold strategy” will be imposed to avoid money being taken out other than through stock market losses, their fees and taxes.

They will say it is in the interest of the fund and its members and quote to you the average length of time before good times roll around again, so don’t worry. Unfortunately they are right because the model rests on everyone staying the course through thick and thin. But it is also in the interest of their jobs and bonuses which are based more on the size of the fund, than it’s profitability.

Baby Boomers are on a timer though. If the markets don’t do what they are supposed to do and turn around according to their statistical averages then you could all be in financial trouble or have to keep working, rather than have a choice.

Bowing to the pressure from investors to move money into safer asset classes and, in an effort to keep your money under their high fees structure, wealth managers have introduced term deposit funds.

They are now offering to put your money into a term deposit under their “professional management” and charge you their usual 1-2% fee for the privilege. I can hear you saying thank you 🙁 You can do this yourself at any bank that right now will be glad to have your money and not charge you a fee.

Until recently wealth managers kept saying cash is a poor investment and will lead to your nest egg not surviving. But who said you would keep all your nest egg in cash for ever?

If cash was such a bad thing to have why are they creating all these new cash style mutual funds?

The current wealth management system is broken and it is going to hurt Baby Boomers the most if the market doesn’t recover in quick time and move up quickly.

Maybe funds will start to consider other asset classes in future apart from the four they usually put your money into, so that much more of your money is far more diversified and truly provides the protection asset allocation and diversification are supposed to provide.

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