What matters more than market timing and stock picking

Sometimes, in investing, we spend far too much energy to find the “best” stock and figuring out the right timing to invest. It feels like these choices should matter most. After all, they are what everyone talks about on twitter, tv, and telegram.

I used to think like that a while back. Then I realized that long term wealth needs first-principles thinking.

A landmark study by Brinson, Hood & Beebower highlights a key trait of long-term wealth building.

In 1986, the researchers looked at the actual performance of 91 large pension funds over a full decade. These were serious portfolios, run by professionals with teams, research desks and sophisticated tools. You would think that these folks would be able to pick the absolute best stocks or time the market to perfection.

Well, no. The results surprised the whole industry.

Of all the returns generated by these portfolios:

• Almost 94% of the variability in returns was due to asset allocation decisions.
• Around 6% was other factors. Only 4% was security selection and 2% was market timing.

Long-term outcomes are shaped by asset allocation.

Think of it this way:

• Asset Allocation is the structure of the building.
• Selection and Timing are the paint and the decor.

The decor adds flavor, makes your house look beautiful but the structure determines if the house stands during a storm. Your allocation defines the longevity of your portfolio, risk capacity, stability, and ability to balance growth with protection.

The beauty of the Brinson, Hood & Beebower study is that it brings investing back to something calm and understandable. Which is, you need a mix of assets that matches how you live, how you think and how much volatility you can endure without losing sleep.

In the end, getting the big things right matters far more than obsessing over the small ones. And in investing, the “big thing” has always been and will always be your allocation.