Back in 1986, a study by researchers Brinson, Hood, and Beebower concluded that over 90% of the variance in pension fund returns was determined by their asset allocation decisions rather than the individual equities they chose. Investment advisors like to abuse this statistic for their own gain.
What the researchers did was to replace the pension funds’ individual equities with appropriate indexes and see how much the returns changed. It turned out that they didn’t change much. When a pension fund allocated a fraction of its money to mid-cap stocks, it tended to choose a broad mix of mid-cap stocks that performed very close to the average of all mid-cap stocks. The same thing happened for other asset classes. This isn’t very surprising.
Christopher L. Jones observed in his book, The Intelligent Portfolio, that investment advisors abuse this 90% statistic to steer investors toward investments that are profitable for the advisor. I didn’t recognize it at the time, but I had an investment advisor use this approach on me early in my investing life.
Many investment advisors use a hierarchical approach where they first choose an asset allocation, and then choose individual investments (usually mutual funds) that satisfy the required asset allocation. The implication is that the asset allocation is much more important than the individual investments.
However, choosing a set of mutual funds with high expense ratios is going to hurt the investor’s returns seriously and pay the advisor handsomely no matter what asset allocation is used. Investors need to pay attention to both asset allocation and the expected returns of the individual investment choices.