Why simple rules are best when spreading your investment bets

BENJAMIN GRAHAM is considered the father of value investing, the business of picking stocks that are cheap. He might also fairly be described as the father of not trying to pick stocks at all. In his book “The Intelligent Investor”, Graham distinguished between two archetypes. Enterprising investors are willing to devote time and care to stock-picking. Defensive investors want a quiet life. So they should simply buy a diversified list of leading stocks instead.

The emergence of low-cost indexed funds has made it easy to be this kind of know-nothing investor. Yet there is still a decision to make, namely asset allocation. How much of a portfolio should be in risky stocks and how much in safe bonds? In theory the split depends on expected returns, volatility (how much asset prices fluctuate), the investor’s appetite for such volatility—and even the investor’s age and job. Thankfully Graham had a simpler answer: a 50-50 split between stocks and bonds, maintained by adjusting as required by market prices.

The merit of this approach—or indeed the 60-40 rule favoured by many pension funds—is simplicity. There is a better chance of sticking to a simple, fixed-weights rule than a complex one. Deciding on the right portfolio weights is not the most important part of asset allocation. What matters is sticking to whatever weights are chosen. And that requires...

via The Economist: Finance and economics Business Feeds

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