Old standards vs new ideas

Larry MacDonald, of the Canadian Business blog recently published a  4-part series [Addendum: It's now up to 7 parts, and counting] that offered a number of quotes from people who vigorously support the merits of passive investing and its superiority to active investing.

I confess that I also believe that  for most individual investors who try to pick winning stocks or who buy mutual funds, that it's better to go passive and save the expenses and fees charged by traditional mutual funds.  So I'm a minor fan of index funds.

That rationale is part of the reason I trade options on a broad based index (RUT), rather than on individual stocks.

I left a comment on each post in the series, but received no replies.


Here's one such quote from Rick Ferri: "Asset allocation is the cornerstone of a prudent investment plan and is the single most important decision that an investor will make in regard to a portfolio.”

There is excellent evidence that the above statement was true.  The important question is: Is it still valid today? 

Those who support this idea never question how well it has done in recent years.  They have an idea that they can sell to the public to gain their trust - and then sell them investing advice – both fee based (better for the investor) and commission based (a very poor choice).

I believe the lessons of 2008 show that asset allocation no longer provides the safety net that it did at one time.  Today's investor should place less reliance on the powers of allocating assets and pay more attention to protecting the value of an investment portfolio by using options.  The global marketplace makes it much more likely that previously uncorrelated assets will rise and fall together.  There is no proof that my belief is true, but one more debacle similar to last year should be evidence enough.


I also post comments on Larry Swedroe's blog, Wise Investing. He and I have many areas of disagreement, but the primary one is that he fails to see the benefits of using options to hedge a portfolio.  He prefers buy and hold (long enough to convert profits to long term) coupled with portfolio rebalancing and proper asset allocation. That's just too old-fashioned for me. But it does keep his clients happy, and paying fees.

I trust a collar to protect my assets far more than I trust those out-of-date ideas.



8 Responses to Old standards vs new ideas

  1. semuren 11/18/2009 at 6:24 AM #

    Greetings Mark:
    I think you make a good point (and Jared at Condor Options had a related post a week or so ago) about using options to protect a portfolio. While there are merits to asset allocation approaches, as far as I can tell they are based on getting the diversification benefit of non-correlated assets (I think this all comes from Modern Portfolio Theory). But this doesn’t really work when in a crisis all asset classes become highly correlated.

  2. Mark Wolfinger 11/18/2009 at 7:33 AM #

    Hi sem,
    The professional financial planners and advisors who build portfolios based on such asset allocation do not agree.
    They fail to see that asset allocation – which did a fine job years ago – may (not yet proven) no longer be reliable. Not yet proven that asset classes are highly correlated, but 2008 suggested they are.
    To me, it’s refusal to learn something new to protect clients. All they want is to collect fees.
    To them, I speak heresy. I don’t understand their (selfish, IMHO) stance.

  3. jeff partlow 11/18/2009 at 7:41 AM #

    I read your back-and-forth with Larry and I agree with your points 100%. After reading his latest book, I had an email interchange with him regarding covered calls which was remarkably similar to yours. Ultimately, I concluded that he is arrogant in defense of his writings; and thus is unable to objectively consider any alternative viewpoint or data.

  4. Mark Wolfinger 11/18/2009 at 8:06 AM #

    I guess he is just a stubborn, ‘I’ve made up my mind – don’t confuse me with the facts’ guy.
    I don’t get it. It’s not as if he cannot update his thinking and provide better ideas for his clients. That what a fiduciary does.
    He also enjoys knocking covered call writing. I don’t get that at all. It seems that he does not like the idea of better returns and reduced volatility because those returns are skewed.
    And he totally ignores any other uses for options.
    Maybe, one day, the public will see that the planners/advisor industry contains more salesmen and fewer fiduciaries than it should.

  5. Donald W. 11/19/2009 at 10:58 AM #

    Yes, there is proof you are correct. The last year and a half, buying protection would have protected and allocation would have all went under at same time.What more proof does one need?

  6. Mark Wolfinger 11/19/2009 at 11:17 AM #

    I’d refer to that as one excellent example not proof.
    Those who make their living charging fees for allocating assets, among other things, are not going to be easy to convince.
    If that is true, who can educate the public? Must convince journalists and respected writers with large reach to adopt this message.

  7. semuren 11/20/2009 at 8:04 AM #

    Greetings Mark:
    I think you are suggesting that asset classes have become more correlated in the wake of the financial crisis, if I read you correctly. What I would argue it that while they may sufficiently uncorrelated most of the time it is just when one really need the protection of diversification that it goes away. In other words in a panic, or most panics, most or all asset classes temporarily become much more positively correlated. Either way – temporary crisis based correlation or a permanent increase in correlation – using options as protection would work and asset allocation would not.
    I imagine that you must feel a lot of frustration in having some of these discussions.

  8. Mark Wolfinger 11/20/2009 at 8:51 AM #

    Greetings semuren,
    The frustration is huge. But, I am arguing with people who believe their livlihoods are at risk if investors no longer believe what they preach.
    In reality, professional planners can steer their customers towards option strategies and maintain those clients. Too subborn. Too short-sighted. Too unwilling to learn about alternativs.
    I don’t know whether it was the financial crisis or the fact that markets are globalized – but I see correlations growing and the asset allocation strategy requires lower correlaions.