Asset Allocation Is The Champ

Over the past 25 years I have learned more about investing each day. The one lesson I have learned over and over again is that we should ignore most investment ideas, even the good ones. 

Why Most Investors Fail

We know that 70-90% of investors, depending on the time frame, trail the stock market averages. If investing were a perfect bell curve, that should only be about 50%. Why then do so many fail to beat the indexes? 

There are two reasons in my opinion. 

Emotional Trading

People buy too late after prices on assets have already risen substantially. That does not apply to just stocks. More and more people are bidding up real estate again. What we are seeing in 2019, is similar to what we saw leading up to the “Great Recession” and financial crisis of 2008-2010. 

Emotional investors also sell too late after prices on assets have already fallen dramatically. Folks who sold stocks in early 2009 only compounded the damage. I saw colleagues liquidating portfolios when clients called or met with them, in January 2009, after seeing their year-end statements down 30% or more.

No amount of explaining could keep those people invested. And why would it, weren’t those the experts that were supposed to protect them? 


The other reason that investors fail is very bad asset allocation that leads to “diWORSEification.” People wrongly believe that spreading their money across many assets is safer than other methods of asset allocation. That is in fact wrong. Plainly, simply, wrong. 

Zacks has a statistic based on their ranking models that shows investing in the top half of investment sectors only, improves performance about 80%. That is an amazing statistic. 

By avoiding the bottom half of investment sectors, you can dramatically improve your investment results and reduce your risk. Certainly, it is impossible to asset allocate perfectly, but that doesn’t mean we shouldn’t strive for perfection.

Perfection is not attainable, but if we chase perfection we can catch excellence. — Vince Lombardi

Invest In A Real Asset Allocation

In 2009, I did not have the problem of having people sell near the bottom. Why? We came close to breaking even during 2008. How? Very good asset allocation and a small hedge on the banks (we bet against the banks).

Asset allocation is the process of determining which asset classes you want to be invested in. Our 4-step process for investing begins with analyzing the secular economic trends. From that we can build three groups of asset classes: 

  • Asset classes with secular tailwinds.
  • Asset classes with secular headwinds.
  • Asset classes that are cyclical in nature or difficult to ascertain direction. 

From those three groups what are the first two steps to building your asset allocation?

  1. Exclude the asset classes with secular headwinds.
  2. Include the asset classes with secular tailwinds and overweight by the amount that you excluded.

What do I mean by that? Here is the S&P 500 by sector breakdown as of May 2019. It changes, but not much. Visit their website for an up to date view.

I believe that financials and consumer staples are facing the largest secular headwinds. So, I do not invest in those. That gives me 13.3% + 7.2% or 20.5% of my asset allocation, that I can invest in the sectors that have the biggest tailwinds, which I believe are technology and materials over the next decade or two.

That means I will invest at least 21.7% + 2.7% + 13.3% + 7.2% or at least 44.9% in technology and materials. Most of that will go to technology, though materials will also be overweight. 

That leaves a lot of other sectors to think about. 

How To Invest In S&P Sectors In The Middle?

While you might not agree with my broad sector thoughts, the process here is what to consider most. 

I believe a large part of the Health Care sector is on the verge of a major bear market. Biotech will likely be an industry exception within the health care sector though and has upside despite being quite risky. I am reducing my health care weighting as a result, in about half, with the allocation I keep focused on innovative biotech. That leaves me about another 6% to 7% to invest into tech and materials, or trade. 

Communication Services has been realigned to include telecoms like AT&T (T) and Verizon (VZ), cable companies like Comcast Corp (CMCSA) and Charter Communications (CHTR), as well as, media delivery platforms like Google (GOOG), Facebook (FB), Netflix (NFLX) and Disney (DIS).

I like the communications sector as a whole, but I think there will be winners and losers in the group. That group now makes up the SPDR Communication Services Select Sector ETF (XLC) which I won’t own because of the mixed bag among the constituents. I am likely to keep a nearly full communications services allocation, however, because a few of the companies have great risk to reward characteristics. 

Consumer Discretionary is generally a very good sector, except just before a recession. I am likely to keep a full weighting in the SPDR Consumer Discretionary ETF (XLY) or pick a basket of several stocks to be my proxy for the basket. 

There is an exception with consumer discretionary though. I think we are closing in on a recession soon (2020-21). So, I am cutting my weighting and adding to my cash balances for now. The idea is I will add back to consumer discretionary coming out of a recession. 


I look at Industrials and Utilities in a very similar fashion. Both are being impacted by paradigm shifts that will create winners and losers, but not change to their relative performances versus the index very much. As such, I will try to pick a few winners in each space with roughly market weights. 

Industrials are seeing supply chains moving closer to consumers due to machine learning. Companies that can adapt and adopt the best that technology can do for them will be the winners. Slow movers will see massive loss of market share. The slow moving and high debt companies are candidates for extinction. 

Utilities are seeing alternative energy and a smart grid emerge faster than anticipated. The utilities embracing this change and making smart evolutionary decisions stand to do very well. Those that are hanging onto the past and focusing on higher dividend payouts at the expense of transitioning to sustainable business models are likely to suffer dramatically at some point. 


Real estate is the sector that I believe is likely to get massacred in the next recession, which I mentioned above I think is coming soon. I have nothing in REITs right now and am trading that money instead.

Remember, we live in real estate, so if you own property, you are already exposed and should consider if you have too much exposure in my opinion. A quick note on real estate: most money in real estate is made in development and redevelopment. Be careful thinking real estate in general is a great investment, it’s not, never has been, the numbers show that.

Because the SPDR Real Estate Select Sector ETF (XLRE) is too new, I compare the Vanguard Real Estate ETF (VNQ) to the SPDR S&P 500 ETF (SPY). You can see that there is no real advantage to REITs, which make up a huge portion of the real estate index ETF:


The energy sector is in the very early innings of “the end of the oil age.” Coal is in the middle to late innings as the end of its game approaches. Natural gas is facing a long choppy sideways period before entering its end game sometime in the middle of the century.

I am trading the volatile energy sector and am currently overweight. However, I can see being a net short in the not to distant future.

So, you can agree or disagree with my quick thoughts on each sector, but should go through the process. Also, you should consider domestic vs international investing as well. I rarely have more than 12% (1/8th) or so of my money invested in international companies. I can see where raising that to 25% soon will make sense. 

Focus On Great Stock Ideas

For the portion of your portfolio that you want in stocks, remember this quote from Warren Buffett: 

I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all… Under those rules, you’d really think carefully about what you did and you’d be forced to load up on what you’d really thought about. So you’d do so much better.

With that in mind, I have created two focus lists for our stocks called the Dividend 30 and the Growth 30. You can find both lists in our “Very Short Lists” spreadsheets. Why lists of 30 stocks instead of 20? Well, I’ve made an image to explain: 

Punch Card Stocks

It is easy to buy stocks. It is even somewhat easy to buy good stocks. The problem is that good stocks tend to track the market in performance and risk. It is only the great stocks, that top decile, that outperform over extended periods of time. We are looking for those companies. 

By only committing our money to companies that are great or becoming great, we can build a margin of safety. A margin of safety around what? Well, sometimes we’re wrong or things just go wrong. If we avoid the middle of the market as much as possible, it becomes less likely we slide lower than that.

Risk management dictates that we not settle for potentially good stocks. We can use ETFs to get exposure to sectors and industries that we like and might not have the time to find the specific companies. 

Building Your Asset Allocation

This section is short and builds on the Intelligent Asset Allocation special report in the Getting Started section.

You will need to decide how to split your investments between fund based investments (ETFs, mutual funds & 401(K) subaccounts) and stocks. Once you have around $50,000 saved and invested (inclusive of retirement plans at work), you should start to accumulate stocks from great companies and companies that are on their way to becoming great.

Building your stock portfolio up from about a half-dozen stocks to a dozen to twenty and then eventually thirty over a period of years is the great approach. By taking several years to build your portfolio, you give yourself the time it takes to do the appropriate research.

Avoid the idea that there is a ready made stock portfolio for you. Other than the weeks after a major bear market crash, it generally will take several years to build a full portfolio. From time to time, you will replace a stock that is beginning to fall from greatness. Be patient. Be diligent.

If you do not have time to monitor thirty stocks, then stop at a dozen or twenty and carry those stocks around your funds. Get to know your companies very well, afterall, you are an owner.

As always, more to come soon. 


Disclosure: I am/we are long GOOG, T. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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