Why Asset Allocation Doesn’t Matter Very Much

A helpful reader sent me a WSJ article with the provocative theme that all this investment advice about asset allocation doesn’t matter for most people. Why?

For the vast majority of savers, improved investment returns won’t materially extend how long retirement money lasts. That’s, in large part, because few investors have enough money in their retirement account to tilt the balance.

Far more important, says the paper from the Center for Retirement Research at Boston College, are three variables that don’t require a brokerage account: how long you work, controlling spending and tapping the value of your home.

Briefly, the study found that 47% of households would fall short of their income needs in retirement at age 67, when Social Security kicks in for those born after 1960. However, even if investors were able to theoretically earn a guaranteed 6.5% above inflation annually in a riskless investment, 44% would still be short.

How little are people saving? The WSJ article notes that having $500,000 in financial assets by retirement age would put in you in the top 10% of savers. The CRR working paper itself mentions that “the typical 401(k)/IRA balance of households approaching retirement is less than $100,000″ but I didn’t see a source.

The Employee Benefit Research Institute (EBRI) found that in 2010 the average IRA individual balance (all accounts from the same person combined) was $91,864, while the median balance was $25,296. EBRI also found that at year-end 2010, the average 401(k) account balance was $60,329 and the median account balance was $17,686. But that’s for all folks, not just people of retirement age.

This shouldn’t be too surprising. Your savings rate is the most important factor in determining if you can retire comfortably. Working longer is the same as saving more and spending less (for a while). Getting used to spending less now would aallows you to need less in retirement. Doing a reverse mortgage is just another word for cashing in your savings, isn’t it?

Why asset allocation is still important. The paper concludes that financial advisors should focus more on savings rates and less about the complex ETF portfolio they just designed for you. Probably true. However, asset allocation has always been something that we did to help our situation without actually doing the hard work of having to save more. Imagine a pill that we could take to lose weight, while not actually eating less or exercising more.

I suppose we should view designing an asset allocation more as a potential “boost” to our nest egg than the driving force, and realize that earning an extra 1% or 2% a year won’t help if you’re just compounding a small chunk of your income. How much is enough? Studies have found that a savings rate of 16.62% would have worked out well historically.


  1. Baughman says:

    Good article. I echo that most important predictor of retirement success is the ratio of income spent / income earned. It seems that too many of us are focused on the income/savings side of things. It’s far easier to learn how to live on 30% less than you currently spend than it is to increase your savings from 500k to 800k. The irony is that you can live just as well on 30% less if you develop appropriate habits. Trade in your ski boat for a pair of tandem kayaks. Trade in your motorcycle for a bicycle. Trade in your trip to Europe for a backpacking adventure at your closest national park. Trade in your $200/month cable subscription for a $3/year in late fees at the library. None of these changes diminish quality of life in any way; in fact, they augment it while obliterating poor spending habits.

    It’s about time that our society leverages manufacturing and technological progress to enjoy a higher quality of life and to stop buying ever and ever shinier trinkets, and working 80 hrs/week to do so.

  2. VERY true.

    I think my family has the *saver gene.* There are several relatives in my family who never made big wages and never put a penny in the stock market (kept it all in cash). & a lot of them are millionaires. & even the ones who took more risks and are multi-millionaires were always heavy in cash. Their savings rate was always quite obviously their biggest edge. Throw in a few good investments/luck and the results are mind-blowing.

    Of course, some of the savers in my family were extreme, but my parents always were very well balanced. I agree with Baughman. I don’t equate saving with deprivation in the least. But we are very efficient, don’t waste money on fees and things that don’t matter to us, and therefore have much more to save. one can save 30% of their income while living very well.

  3. Most of the literature on the importance of asset allocation was originally developed for institutional portfolios where the presumption was that the level of funding was appropriate to the level of liabilities and therefore the problem to be solved was to quantify the trade-off between risk and return in optimal portfolios. Individuals naturally adopted the conclusions drawn in that research. But I agree that it doesn’t matter whether you have an efficient portfolio if you are woefully under-saving for retirement. But I would argue that most of the individuals who are engaged enough to implement some of this portfolio management theory are in the group that has a relatively well-funded retirement portfolio because they tend to be focused on retirement, potentially higher-educated, and/or higher earning individuals. I really doubt that many of those who have only saved $10k towards their retirement by middle age are spending a lot of time reading up on asset allocation theory.

  4. “One can save 30% of their income while living very well”. Ha! Millions of families in the US barely have the ability to pay their bills much less have anything left over to save. Millions more think that their automatic 5% into their 401k will be enough to retire on. Millions more don’t even know enough or care enough to put anything away at all!

    The retirement of these people will have to be paid for… somehow. With the pattern of the responsible people insuring the failures of the reckless that has been showing up as of late, I fear that we 10% of savers will be footing the bill in some way or another!

  5. Baughman says:

    I should have clarified, the best predictor of retirement success is the ratio of current expenditures to current net worth.

  6. I think if your savings are very small then nothing much matters, not just asset allocation, right?

  7. Thanks for the nice summary.

    Is higher earning more important than asset allocation? Yes, I will work harder and get a higher paying job.

    Is higher savings more important than asset allocation? Yes, I will find ways to live on less without compromising quality of life.

    Is asset allocation important? Yes, way better than keeping all my earnings in cash only to see it loose value with inflation. I will continue to keep at my simple, low cost, diversified portfolio.

  8. Tyrone Biggums says:

    +1 on what Baughman posted. The average investor will be better served by learning to cut back on spending, instead of struggling to save more.

    But I’ll admit this can be tough in our Jones-chasing society. I was fortunate to learn about the importance of saving in my early 20s (by my mega-saver parents). I was a Boglehead immediately, and have read books by Bogle, Bernstein, Ferri, etc. So I know the importance of saving. But even I struggle with avoiding spending. What hope does an average person have who knows nothing about saving/investing?

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