Investors who embrace passive investing often spend a lot of time agonizing over their asset allocation percentages. I used to be no different. However, I now think that sticking to a strategy may be more important than the percentages.
When researchers do back-testing of passive investment returns based on fixed asset allocation percentages, a key assumption is that investors would actually stick to these percentages. However, this is more difficult than it seems.
The truth is that many so-called passive investors reduce their allocations to stocks right after a stock crash and increase it again after stock prices soar. Allocation percentages will naturally rise and fall as stock prices move, but many investors go beyond failing to rebalance; they sell at low prices out of fear and buy back at higher prices. This is disastrous for long-term returns.
Unless you have a far-out plan like leveraging yourself to the eyeballs and dividing your money equally among junior mining stocks, Greek bonds, and hog futures, I think that the ability to stick to a plan is more important than using the perfect asset allocation percentages.
People discuss whether they should have 15% or 20% in an international stock index, but they rarely think about whether they’ll be able to hold on (or even rebalance) through a stock market crash.