ITA Wealth Management

If asset allocation, passive investing, use of index funds, and ETFs are so great, why is it that only a small percentage of investor use this approach to portfolio construction? Here are a few reasons why this may be the case.

• The popular media does not emphasize this approach to investing. Selecting individual stocks rule the press and air waves.
• Investors do not understand the power of diversification across a wide range of asset classes. Including non-correlated asset classes, while not easy to find, is a way to reduce risk while maintaining a respectable return.
• A broad asset allocation plan will almost always include asset classes that are out of favor. It goes against the grain of investors to include such asset classes.
• It is not uncommon for investors to take the approach - why invest in an index or ETF that includes an array of “poor stocks” when I can select only the “best stocks” from the basket of stocks that make up the index or ETF?
• Investors are unaware of the academic research behind the principles of asset allocation.
• Passive investing is boring. There is not enough action. Where is the hot stock to discuss with friends?
• Asset Allocation requires laying out a plan for a portfolio.
• Brokers do not encourage clients to use a passive approach as it reduces commissions.
• Portfolios built using ETFs and/or index funds are defined as settling for less than the best. One does not race to the front of the class with a passive portfolio built using index investments.
• Investors tend to take a short-range view rather than one that stretches out over many years.

While there must be other personal reasons for sticking with stock selections, it becoming more and more difficult to support this position as we are increasingly investing in a global economy. Most small investors are ill equipped to buy into the emerging and developed international markets. ETFs make it easy to enter these markets.

I should add that most endowment and large pension funds use the principles of asset allocation.

Lowell Herr

Photograph: On the grounds of the Sultans of the Ottoman Empire. Photo by Dennis Dean