The Prosperity Blog

“Down Goes Math! Down Goes Math! Down Goes Math!” (Again): Will Asset Allocation Keep Working?

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Joe Frazier was a feared boxer, a heavy-weight champion who, between 1971 and 1975 fought three momentous bouts with Muhammad Ali, winning once. In 1973, he fought a relatively inexperienced George Foreman in Kingston, Jamaica. Foreman had been a 1968 Olympic champion, but the veteran Frazier was a prohibitive favorite. The fight was no contest. Foreman knocked Frazier to the canvas six times, and ended the fight with a 2nd-round knockout. The legendary sports commentator Howard Cosell was at ringside calling the fight. As Foreman pummeled Frazier, a stunned Cosell, uttered this famous refrain (that is so legendary you can even buy as a ringtone for your cellphone):

“Down goes Frazier!
Down goes Frazier!

In the world of financial mathematics, a “veteran” financial formula has taken a similar beating as a result of the recent stock-market decline. Asset Allocation is a historical, mathematically-driven approach to investing that attempts to select investments from different asset classes to form a diversified portfolio, with the idea that the mix of investments will limit losses and smooth out returns.

At the mathematical heart of the Asset Allocation strategy is the matching of disparate asset classes – ones that move up when others move down, and vice versa. This disparity is quantified by using a correlation ratio; if two investment classes perform exactly alike, their correlation is 1, while asset classes that perform quite differently might have a correlation of 0.2. For most asset mixes in the United States, the benchmark asset class is the S&P 500 stock index, against which all others are compared.

Asset Allocation has a long history. It first appeared in the 1950s, and Harry Markowitz, a pioneer of Modern Portfolio theory, was awarded the Nobel Prize for his work. As Wall Street Journal reporter Tom Lauricella writes in a July 10, 2009 Wall Street Journal article (“Failure of a Fail-Safe Strategy Sends Investors Scrambling”), “asset allocation became ingrained in nearly every corner of Wall Street.” For over four decades, asset allocation was used in all sorts of financial products and delivered consistent, almost predictable returns.

But the last two years have not been kind to Asset Allocation. Lauricella notes that when the S&P 500 dropped 47% from March 2008 to 2009, many asset allocation funds performed even worse; their diversification didn’t work as a buffer against losses.

What happened?

The analysts interviewed by Lauricella noted two significant changes. First, globalization of the economy means greater correlation and less opportunity for diversification. The economy in China is connected to the economy in Europe, is connected to the economy in America – when they all act the same, you can’t diversify by investing in different regions.

Second, the popularity of diversification may actually make it a less useful strategy. As analyst Vineer Bhansali said, “when (lots of) people start buying an asset, the act of them diversifying actually makes the asset less of a diversifier.”

Money managers are divided about whether Asset Allocation is finished as a viable model. The value of diversification still seems logical and useful, so some adherents believe the process simply needs tweaking. But others see it as a relic of a past economic era – the “new” economy will require a different method of diversification.

But either way, there is a financial lesson that bears repeating: While events in life can be cataloged and categorized, life cannot be reduced to a mathematical calculation. This is especially true about the use of formulas to predict the future. There are too many variables that can change, and too many ways for the changes to be unforeseen. And just because something is improbable does not mean it is impossible. A primary objective of a good financial program is to adequately address all possibilities, not just those considered most likely.

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Using a Lottery as an Incentive to Save

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According to Wikipedia, behavioral finance is a “separate branch of economic and financial analysis which applies scientific research on human and social, cognitive and emotional factors to better understand economic decisions by consumers, borrowers, investors, and how they affect market prices, returns, and the allocation of resources.” Among the things behavioral finance studies are the factors that influence people to make bad or short-sighted economic decisions. For example, why do many people opt for the unlikely chance of a big payout from gambling, and avoid the sure-fire success of regular saving?

As Jason Zweig notes in his July 18-19, 2009 “Intelligent Investor” column in the Wall Street Journal, “in 2007, the latest year numbers are available, Americans spent $92.3 billion on legalized gambling, according to Christiansen Capital Advisors; that same year, says the U.S. Bureau of Economic Analysis, Americans saved only $57.4 billion.”

Why do Americans put more dollars toward gambling than saving? Someone in the field of behavioral finance would theorize that people tend to over-estimate the odds of rare occurrences, like winning the lottery, or breaking the bank at Vegas, in part because the magnitude of reward is so enticing – “I know the odds are 10 million-to-one, but can you imagine what we could do with a million dollars!” Saving, on the other hand, provides minimal thrills, and no chance of outrageous gain. For many, potential thrills trump low-level guarantees. This is especially true with smaller amounts of money. Given the choice between saving $25 or buying 5 lottery tickets, the tendency to gamble is strong, because $25 saved doesn’t add up to much, but a single winning ticket could mean millions.

But what if there was a way to tie the thrill of gambling to the boring activity of saving? This was the idea behind the “Save to Win” program developed by Peter Tufano, a professor at the Harvard Business School.

In a campaign launched in February 2009, eight credit unions in Michigan offered one-year Certificates of Deposit, with a minimum deposit of only $25. These low-minimum, short-term CDs actually pay interest below those of conventional CDs, but come with a unique kicker: With each new CD, the depositor is entered in a monthly and annual drawing. The monthly winner receives $400, the annual winner $100,000. In essence, depositors get to play the lottery when they save money.

Zweig’s article noted the campaign has been quite successful: In 25 weeks, the credit unions attracted over $3 million in new deposits. But some of the best comments come from participants in the program, reporting their experience on the Internet. Here’s one, from “Dean L.” posted in a forum on :

I had less than $5 in my bank account a couple of months ago. This had been a typical savings amount for me for as long as I can remember.

I have read about saving money and have known for a long time that it’s something that intellectually I know I should be doing, but there had never been the incentive for me to do so. The paltry interest rates that banks pay made me feel like it was a waste of time to put aside money, so I took my chances each month and played the lottery instead. It was always $2 here, $5 there, but it added up to close to $100 over the entire month.

That all changed two months ago when I walked into my local credit union and learned about a new savings promotion they were offering called “Save to Win” where if I placed $25 or more into a 1 year CD, I had a chance to win up to $400 on a monthly basis plus a chance at $100,000 at the end of the year. Although the payout isn’t as high as the lottery, it gives me a chance to win something which makes the low interest rates more palatable.

Since that time I have put aside the money that I would have put toward the lottery and instead have placed it into CDs. I’ve opened 5 CDs over the last 2 months which has my savings at more than $125 – an amount that I haven’t had saved in years. I plan to continue to place the money I would have spent on the lottery into CDs for the rest of the year and should have close to $1,000 in savings by then. And if I’m lucky, I may win some cash prizes along the way or $100,000 at the end of the year.

One of the popular books relating to behavioral finance is Nudge (Penguin, 2008) by Richard Thaler and Cass Sunstein. The subtitle of the book is “Improving Decisions About Health, Wealth and Happiness,” and extensive sections of the book are devoted to methods used by individuals and institutions to provide strong incentives for a desired financial outcome, whether it is cutting expenses, saving for retirement, or even spending money on luxuries.

In the paradigm of the book, the “Save to Win” program is an example of what the authors call “Libertarian Paternalism,” which means people are free to choose, but choices are structured to encourage the “better” choice. No one is forced to put money in a one-year CD, but as Dean L. writes, the “chance to win something…makes the low interest rates palatable.”

The next time you have a discussion about your long-term financial objectives (with your spouse or one of your advisors) you might want to consider “nudges” you could include in your financial strategies. You might not be entered into a $100,000 drawing, but any strategy that can help you “save to win” is probably a good one.

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BANKRUPTCY: Proceed With Caution

Last Updated: November 12th, 2020

“The law…is really targeted at the 5 to 10 percent of people who were abusing the system.”

Laura Fisher

When it comes to personal finance and financial advising, bankruptcy is a last resort to stop economic bleeding. And seeking bankruptcy protection is not always a cure-all. People with debts and deeper issues can find themselves in an unrelenting debt trap with limited alternatives. The most vulnerable consider bankruptcy their only option and the only relief in sight when their resources run out. However, bankruptcy is both a catalyst and a cause. 

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STATISTICS: Full of Sound and Fury, Signifying…What?

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Is this a bull or bear market?

It depends on your perspective.

The Standard & Poor’s 500 stock market index is a mathematical calculation of the collective value of selected U.S. stocks. On March 9, 2009 the Standard & Poor’s 500 Index closed at 676.53, its lowest closing value in well over a decade. On June 15, the same stock index finished at 923.72, a 36.5 percent increase in a little more than three months. Since financial analysts often identify a bull market as one in which values rise more than 20 percent over a previous low, the recent run-up certainly seems to qualify as good news for stock market investors. Except…

As the retirement planning website succinctly reported on June 15, 2009, “The S&P 500 is 36% above the March 9th low, but 41.2% below the October 2007 high.” A bear market is usually identified as one where values are 20 percent below a previous low.

So Is It A Bull Market Or Still A Bear? 


Which means…it may be a secular bear market.

A “secular market” is defined as one where the long-term trend is up or down (i.e., bull or bear), but punctuated by periods of significant counter-trends. A secular bull market will include some bearish periods, a secular bear market will still have some bullish moments.

According to, secular market trends since 1900 have lasted from 5 to 25 years. During this time there have been three secular bull markets and three secular bear markets. The last secular market was a bull – the long-term trend was upward – and began in 1983. When did the bullish trend end? It depends on your perspective. Some sources will say 2000, others point to 2007. One of the characteristics of secular trends is that it takes awhile to identify them.

An Analysis of Secular Bear Markets and Secular Bull Markets since 1900, issued by in June 2009, identifies the secular bull and bear markets using S&P 500 data. But the time period from 2000 forward ends with a “?”; in other words, after nine years there’s still no conclusion on whether the long-term trend is up or down.

Statistics may accurately represent historical events, but still need a framework in which to interpret them in order to be useful. The perspective matters as much as the math.

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Will You Stay-the-(Financial)-Course or Make a Change?

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In any election, at every level, the basic issue presented to voters is, in some fashion, a question of whether to stay the course or make a change. 
When the vote is between candidates, one (often the incumbent) is a proponent of staying the course, continuing things as they are, while the other candidate offers a change – a new list of priorities, a new way of doing things. When the vote concerns an issue (taxes, public funding, laws) the decision is still whether things should stay the way they are or be changed. How you decide to vote depends on your perspective. Your decision to stay the course or pursue change doesn’t really hinge on facts, but on how you interpret the facts. 
Similarly, your financial decisions are really based on your financial perspective. And just like a voter, you must decide: should I stay the course or is it time to make a change?  

A New Direction

Because of the ongoing economic crisis / turmoil / downturn / depression, many people are looking for fresh financial direction. They want someone to help them stop the losses – the loss in their retirement account or stock portfolio, the loss in their real estate values, the loss of their job.

The losses people have experienced are facts. But before you make another financial decision, you may want to first reconsider your financial perspectives. While a financial loss may be an indicator that some things need to change, the specific actions to correct the situation depend almost entirely on your financial philosophy.

In a segment of life that seems to be dominated by mathematical data, the idea of looking first at your “financial philosophy” – whatever that is – may sound a bit “out there”. For many, their overriding financial philosophy is pretty simple: “I don’t care much about the ideas; I just want to do whatever makes the pile of money bigger.” But because mathematical assessments can only be made about the past, you can’t make future decisions based solely on which decisions produced the biggest pile last year, or last week. Instead, you need a financial perspective that can interpret the events from the past in a way that gives some direction for the future.  

Are The “Incumbent” Financial Philosophies Still Valid? 

Historically, the past three decades produced several significant trends that influenced conventional financial thinking. As a result of recent events, each of these developments, once thought to be almost a “sure thing,” is receiving skeptical scrutiny.    

As values have plummeted in a manner not seen since the Great Depression, people are asking… 

Is The Stock Market Worth the Risk?

After three decades of trending upward in a steady, profitable course, it was common for financial observers to conclude that the financial markets offered the greatest opportunities for investment reward. And the expansion of the mutual fund industry meant even small investors could reap big-time profits.

However, the steep declines since the all-time highs in October 2007 have left many people reeling. Investors may have always known that returns aren’t guaranteed, they may have even experienced periodic short-term losses. But the majority of investors never expected to see 30% to 50% of their account values wiped out in one year. Very swiftly, planning for next year’s retirement became planning to keep on working, and hoping for enough time to recover from the losses.

As real estate values have declined, and foreclosures continue to glut the market, people are asking…

Does It Still Make Sense to Invest in a Personal Residence? 

The realtor’s mantra is, “Your home is your greatest asset.” Buy in with as little down as possible; use the appreciated equity to keep trading up. It wasn’t unusual for a $5,000 down payment on a starter home to result in a $1 million mansion 10 years later. And if you didn’t use the equity to trade up to a larger residence, you could always open a home equity line of credit to tap your gains.

Every part of this scenario worked – until the economy slowed. Defaults and foreclosures started to pile up, and housing values started to level off, and then drop. In a flash all that equity vanished – poof! For some, the loss has turned them upside down – they owe more than the house is worth – and they face two choices, neither of them good. They can continue making mortgage payments, knowing it may be years before the payments result in any equity. Or they can simply walk away, taking a hit on their credit history and losing whatever they had invested.       

As employment has become more tenuous, people are asking…

Should I Keep Maximizing My Qualified Retirement Plan? 

The conventional wisdom was “a path to a bountiful retirement was through maximum contributions in an employer’s 401(k)”. The tax deduction on deposits and the tax deferral on the earnings could make for some gigantic long-term compounding opportunities. With automatic withdrawals and loan provisions in many plans, it was easy to keep pouring in the maximum from each paycheck, and take some out for emergencies. And savvy investors didn’t have to accumulate years of service or wait until age 65 for a pension – retirement could happen on your timetable.

But a few things misfired. It turns out almost no one was a savvy investor – not the employee who asked his co-workers for advice or the professional money manager. And many of the outstanding loans became due in full when employment was terminated. For some who lost their jobs, their only financial resource was their retirement account, and many withdrawals resulted in income tax penalties.

As budgets get tighter, more people are asking…

How Much Debt Should I Carry? 

Credit is the grease of commerce. It allows people to obtain things now and pay for them over time. The use of credit makes people homeowners – and business owners – sooner. For manufacturers and service providers, it boosts sales – of cars, computers, office equipment, travel, everything. Smart and industrious entrepreneurs have used credit as the springboard to turn great ideas into fabulous fortunes.

Of course, there’s also the recognition that your ability to borrow is dependent on your ability to repay. You can’t borrow indefinitely – at some point, you have to pay it back. Or you have to declare bankruptcy and start over. Right now, there’s a sense that many Americans have reached their credit limit.

And What About the “New” Financial Candidates? 

As some of the incumbent financial philosophies have staggered, a host of options have emerged. Many of these ideas aren’t new, but circumstances have given them renewed relevance.

The fallout from the declining markets, rising unemployment and the credit crunch have resulted in greater government involvement in what once was considered the “private sector” of Americans’ financial lives.

  • There has been a massive infusion of government stimulus spending and bailout assistance from AIG and TARP to Chrysler and GM.
  • As the United States government takes a more direct role in “managing” the national economy, the short-term result appears to be increased government borrowing and higher deficits, along with greater government regulation over products, transactions and compensation.
  • The administration is actively seeking to re-structure the tax code, offering incentives and/or credits to home and car buyers, re-evaluating the estate tax and considering new “sin” taxes on items such as beer and soda pop.
  • Government is also looking to reform the health care system, including a government-sponsored insurance alternative, and digitizing the medical record system.

Regardless of your political persuasion, these government initiatives represent potentially significant changes in the financial landscape – for businesses and individuals. As Jon Meacham and Evan Thomas put it in their cover article for the February 16, 2009 issue of Newsweek: We Are All Socialists Now.  If that’s true, what impact will it have on your financial philosophy?

Is it Time For a Change? It Depends 

Is there a new economic paradigm? Have the losses and government intervention fundamentally changed the rules and strategies for prosperity? As was mentioned at the beginning of this article, how you vote depends on your perspective. For some people, nothing has changed, even with all the apparent economic turmoil. A value investor probably still sees great opportunities in the stock market. A person looking for a home might find fantastic bargains among foreclosures. And a true free-market libertarian already felt the United States economy was essentially socialist – the only difference was the degree.

For others, the events of the past 18 months are forcing them to re-evaluate their approach to financial decisions. A June 2, 2009 Wall Street Journal article titled “Americans Get Even Thriftier as Fears Persist” begins with “Americans are saving more of their paychecks than at any time since February 1995.” “New Horizon, New Behavior,” a survey from Barclay’s Wealth released on June 15, 2009, reported that 68% of wealthy investors are staying out of the stock market – even though 88 percent believe there are profitable opportunities – because they can’t tolerate the risk of loss. As for the possibility of the United States becoming socialistic, a March 26, 2009 Washington Post article reported that many college graduates “now see the government as an employer of choice.”

So…Even though things have changed, you can still make a strong case for staying the course – or making a change. It all depends on the financial philosophy you use to interpret the events.

Times May Change But Good Philosophies Are Timeless 

It’s quite likely that many of the people who feel whip-sawed by the current economic shake-up are those who believed that financial conditions were static – what was happening now would continue in the future. They saw the stock and real estate markets always going up, their employment conditions stable, and their access to credit infinite. If so, that was a faulty interpretation.

Financial history is full of ups and downs. While the events of the past 18 months have been somewhat unusual in their severity, they are not uncommon; in fact, the peaks and valleys occur regularly.

One of the characteristics of a good financial philosophy is that it provides insight and direction to make it possible to thrive in all circumstances – not just the particular trends of the moment.

For example, people with a timeless financial philosophy:

  • Have guidelines for their participation in the stock market or other investment opportunities. This doesn’t mean the guidelines are guarantees. Rather, it means there is recognition (and preparation) for what can happen, both positive and negative.
  • Understand the psychological value and true financial costs of home ownership. Besides price of the home and size of the mortgage, owning a home consists of other benefits and liabilities. There may be tax deductions to consider, as well as overhead costs like insurance and property taxes. Profitable home ownership takes all these issues into account.
  • Know when borrowing can multiply their wealth – and when it should be avoided. Just like a home is more than the price and the mortgage, borrowing is more than the interest and length of term. It depends on whether the borrowing is for emergencies or wealth-building. And even those who are debt-free and not currently looking to borrow should be sure they have access to credit.
  • Balance their retirement savings against emergency and liquidity needs. Much of the hype of qualified retirement plans was built on “Plan A” premises – where everything goes exactly as planned. But history shows there’s often a need for a Plan B.

If the events of the past 18 months have undone your financial progress, now is a good time to evaluate whether you would be better served by an adjustment in your financial philosophy. Not only that, it might also be a good time to ask the same questions of the financial professionals you’ve asked to help you with your financial programs, and see if their financial philosophies are ones that work – and are in line with yours.



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Financial Literacy Question: The long-term trend of financial markets

Conventional financial wisdom says the long-term trend of financial markets is generally upward. Even considering the declines over the past 18 months, what was the annual rate of return for the S&P 500 stock index for the 10-year period ending 3/31/2009? (Source: BTN research)

a. 5.2 percent
b. 3.4 percent
c. 1.2 percent
d. -3.0 percent

Answer: d.

The steep losses in 2008 wiped out all the gains from the previous nine years. According to BTN research, this 10-year period represents the eighth-worst decade for S&P investing since the S&P was established. (The worst 10-year period, from August 31, 1929 – August 31, 1939, registered total losses averaging -5 percent each year.)

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529 Plans Prove Problematic

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On April 14, 2009, the State of Oregon announced it was suing the national investment company responsible for managing its state-sponsored 529 college savings fund. Oregon Attorney General John Kroger alleges the investment company misled families into thinking they were making rock-solid investments for their children’s future. Instead, Kroger says one of the firm’s funds took undisclosed risks that resulted in a 36% decline in value for 2008. In a transcript from a report aired on NPR, Kroger says Oregon families “lost about $40 million, and we want our money back.”

(Actually, Oregon’s argument is not with the losses incurred, but that some funds supposedly structured to avoid or minimize market losses, particularly for those accounts that would soon be tapped to pay for education expenses, were not invested according to the objectives stated in the prospectus.)

As Jason Zwieg of the Wall Street Journal notes in an earlier March 21, 2009 article, Oregon is not alone in losing money. Of the 3,506 options in 529 college plans tracked by Morningstar, Inc. “93% fell in value over the past year, and 1,098 lost at least 40%.”

The main attraction of 529 plans is the tax advantages during accumulation and distribution, provided the funds are used for qualified education expenses. These benefits also come with restrictions: Investment choices are determined by the sponsoring state, transfers and/or exchanges are limited, and funds withdrawn for non-qualified reasons may be subject to both income tax and penalties.

Under normal circumstances, the combination of advantages and restrictions seems to provide substantial incentive for families to invest long-term for their children’s college education. But when the investment portion goes south, things unravel.

Families whose children are ready to enter college are finding their 529 accounts have sustained losses – their current balances are less than their deposits. For families whose financial situation has taken a turn for the worse (lost jobs, foreclosure, bankruptcy, etc.), education plans may be off the table. Yet deciding to access the funds often still means incurring penalties – along with the investment losses.

Other states are considering legal action against some of their plan managers. And even the IRS is trying to help. In an April 16, 2009 CNNMoney’s Carolyn Bigda noted “in light of the market’s recent volatility, the IRS is allowing savers in 2009 to switch 529 plans twice. Normally, you can only make a move once per year.”

According to Zweig, one of the shortcomings of the state-sponsored plans is that “the public’s faith in 529s appears to be based partly on a false premise: that state bureaucrats are good at managing other people’s money.” Clearly, the politicians were no better (or worse) than the rest of us when it came to investment acumen.

Beyond the assignment of blame, there’s a case to be made that 529s are susceptible to this type of turmoil because of the financial philosophy that underlies them. Many government-sponsored savings programs come with restrictions and incentives to encourage a narrow response from citizens. The 529 is designed for families to invest for college in a list of investment options chosen by state officials – that’s it. As long as everything goes well, both for the investment and the individual, the outcome is usually acceptable.

This compartmental approach – a specific plan with a singular purpose – often conflicts with the fluid nature of individual financial lives. At different times people want education money, or retirement money, or down payment money. And many individuals don’t have enough money to leave unused in separate compartments for several years – they would like to use the money they have for the reason that’s important right now. When things go wrong or priorities change, there’s often not enough money in one compartment, or there’s a prohibitive cost for redirecting the money to another compartment.

Given the choice, most Americans would probably prefer a tax-favored account with unlimited accessibility, similar to life insurance cash values – a larger pool of money available for whatever issues or opportunities may arise. Of course, well-intentioned politicians will fret that giving individuals an unrestricted tax-favored account may result in irresponsible spending. And considering the alleged abuses and failures of the financial professionals with 529s, the expectation may be tighter restrictions.

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