What did conservative investors learn from the economic crisis? Traditional asset allocation models are no longer valid. Learn more.
Losses suffered during the financial crisis taught Millionaire investors many sobering lessons. Most stopped seeing their home as a stable financial asset, and many pulled money out of the volatile stock markets, according to research from Spectrem’s Millionaire Corner.
Conservative investors – who tend see events in a more negative light than moderate and aggressive investors – appear most affected by the Recession and express the most skepticism about the validity of traditional asset allocation models used to guide investors.
Nearly two-thirds of self-described conservative investors indicate “investment management needs to reassess their investment models” and 58 percent indicate “traditional asset allocation models are no longer valid in today’s economy.”
Asset allocation models stem from the work of Nobel laureate Harry Markowitz, a finance professor who in 1952 developed Modern Portfolio Theory. The theory is based on a curve known as the Efficient Frontier representing optimal returns at varying levels of risk. The theory allows investors to control for risk by investing in a mix of asset classes. The three traditional asset classes are stocks, bonds and cash and – historically – these classes performed inversely to each other, according to the Financial Industries Regulatory Authority or FINRA. “In most cases, if one asset class is performing poorly, the other two are doing better.”
Risk is the top investment selection criteria of Millionaire investors.
The financial crisis tested the limits of traditional asset allocation models and modern portfolio theory. The models, says Wall Street Journal Blogger Doug Kinsey are not good with dealing with statistical anomalies and are not foolproof. He says, “Modern portfolio theory assumes certain asset classes have reverse correlations – that they’re ‘natural hedges’ for each other. But in 2008 many of those natural hedges crashed at the same time.”
Correlation coefficients can help investors achieve greater diversification.
Aggressive and moderate investors are less wary of traditional asset allocation models, but almost half say they are no longer valid in today’s economy.