Investors Lose Billions in Traditional Asset Allocation Method

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[January 11, 2022]

MARLBOROUGH, Mass., Jan. 11, 2022 /PRNewswire/ — The widespread practice of using an arbitrary asset allocation based only on investor risk tolerance was found to be flawed in several respects. Investors forfeit as much as 37.68%[1] of their returns in an attempt to limit temporary losses while failing to protect essential short term funds. In its new paper, DALBAR has suggested the practice of setting arbitrary asset allocations for investors to be imprudent, not in their best interest and potentially a breach of fiduciary duty. A Prudent Asset Allocation in comparison, does not seek a fixed allocation but instead makes allocations annually to protect the portion of assets needed for the immediate future. These protected assets are insulated from market instability. Prudence dictates that the remaining assets should be aggressively invested to capture the maximum long-term return.

“Reassessing individual investor’s need for cash is the only way to capture the ever-changing situation and act in an investors best interest,” said DALBAR’s CEO, Louis Harvey. He added that, “It is irrational to expect that an investor’s situation remains static from day to day, month to month or year to year! A prudent allocation keeps up when the situation changes.”

In the complimentary paper, DALBAR examined the effectiveness and cost of Arbitrary Asset Allocation in relation to a Prudent Asset Allocation which concluded there is no economic value for the former. The current Arbitrary practices were found to be highly ineffective and costly and therefore imprudent. In contrast, the prudent practice is highly effective in circumstances where it is needed as it is far more prudent to suffer a loss and wait for recovery than to use an underperforming allocation in a futile attempt to avoid a loss.

In support of investors and their fiduciaries, DALBAR has developed resources and tools to take advantage of this prudent approach and use Prudent Asset Allocation practices in 2022 best interest strategies. Learn more about the Prudent Asset Allocation Package or contact DALBAR for further questions.

1 See “Comparison of Arbitrary & Prudent Asset Allocation” table in the paper: “Arbitrary versus Prudent Asset Allocation”. For ten year return at 2020, arbitrary allocation of 40/60 produced net returns of 60.94%, compared to 98.62% for the prudent method, yielding an advantage of 37.68%

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