Morgan Guide to Markets 4Q 2019 as of September 30, 2019Įven in a shorter cycle, S&P annual returns are positive in the last 29 out of 30 years despite an average intra-year decline of 13.9%. The variance of stock returns is less than proportional to the time horizon, which supports the case that stocks are less risky over the long-run, as evident by the S&P Composite Index (charted below).

Several theories are used to explain mean reversion in stock prices, but ultimately it’s said that an upward price movement is likely to follow a decline in stock prices, and vice versa. This has long been debated in academia with the acceptance of what is known as “mean reversion” of returns. The bucketing strategy also infuses “time diversification,” the theory that there is an inherent relationship between the holding period and risk – the volatility of risky assets falls over long periods of time. Each bucket is driven by a separate asset allocation policy that creates a case-by-case, tailored solution that reflects a client’s financial plan. This approach divides a client’s portfolio into several “buckets,” each with different goals, time horizons and risk levels. The bucketing strategy lays the foundation for goals-based allocation, which provides a tractable shortcut to overcoming a one-number risk in a portfolio. Investors are susceptible to this bias when they view recent gains as “house money” that can be used for high-risk investments, according to Richard Thaler’s study “ Mental Accounting Matters. One of the major behavior gaps the bucketing approach tries to alleviate is mental accounting, the theory that people treat money differently depending on its origin and intended use. Psychologists watch what they actually do.”Īccounting for these behavior gaps is the essence of the bucketing approach to financial planning.

The trade-off between current and future spendingĭaniel Kahneman, a Nobel Prize winner in behavioral finance, argued that investors are not always rational in their decision making, saying, “Economists think about what people ought to do.Asset allocation for a goals-based financial plan with a time horizon.However, this conventional approach does not consider three important aspects of investing:

Asset allocation is traditionally conceived in a mean-variance framework pioneered by Harry Markowitz, where an investor strives to maximize the expected return for a given level of risk.

Black litterman reverse optimization