Asset allocation can be one of the most complex areas of financial planning.
Some hedge funds have made billions using sophisticated asset allocation strategies, like Bridgewater, which has built its reputation off the back of its ability to generate steady returns in all market environments. It has used a range of different assets to diversify risk, while at the same time borrowing to improve the returns on low-risk asset classes like bonds.
These strategies might look smart and appealing to the average investor, but replicating them is quite tricky and access to the hedge funds that provide them is unavailable to them.
So what's the solution? How should the average investor build a portfolio to weather all market environments, and what assets should they be buying?
We can look to Warren Buffett (Trades, Portfolio) for the answer to this question. At the 2005 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting, one shareholder asked the CEO for his thoughts on the U.S. dollar and whether or not retail investors should diversify investments away from dollar-based securities.
Buffett responded by saying that it's very tough for individuals to select individual stocks or currencies. And rather than trying to time different macroeconomic markets, investors should focus on trying to improve their own abilities. The Oracle of Omaha went on to say:
"I think that, you know, the best investment you can have, for most people, is in your own abilities. I mean, when I talk to students, you know, I would pay a student β in many cases, I would be glad to, you know, pay them $100,000, cash up front, for 10% of all their future earnings. So, I'm willing to pay 100,000 for 10% of them, I'm valuing the whole person at a million dollars, just capital value standing there in front of me. And those β anything you do to develop your own abilities is probably going to be β or your own business β is probably going to be more productive for you than starting to think about individually making commitments into foreign exchange."
This might seem like a strange response, but it follows what Buffett has said in the past. He has said that the best way for investors to counter the detrimental effects of inflation over the long term is to invest in themselves.
Indeed, Buffett has never believed in market timing or macroeconomic predictions. Therefore, it makes sense that he would not suggest buying equities based on macroeconomic forecasts due to a slump in the dollar or another currency.
On many occasions, Buffett has emphasized the best strategy for the average investor to use is to buy stocks at low prices and hold them over several decades.
This statement supports that viewpoint, albeit with the added requirement for continual learning.
As Buffett went on to add in 2005, the essential part of picking stocks is not where they're located, but their fundamental strengths and weaknesses as a business, as well as the price paid:
"We have 80% of our money, or more β well over 80% β tied to this country and to the dollar. So it's not like, you know, we've left the country or anything of the sort...We end up with peculiar asset mixes. I mean, if the junk bond thing had gone on a little longer, instead of having $7 billion in there, we might have had $30 billion in. But we were doing that simply based on the fact that it was screaming at us. And we do the same thing with equities...for many years, we had more than the net worth of Berkshire in equity positions. But they were cheap."
Disclosure: The author owns shares of Berkshire Hathaway.
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