5.20.2007

Book Review: All About Asset Allocation. By Richard A. Ferri, McGraw-Hill

The elimination of many defined-benefit pension plans and the possibility that the U.S. Social Security system may be overhauled have placed much of the burden and responsibility of retirement planning on the individual. These changes, together with increasing life expectancies, are making the investment allocation decision much more critical than in the past. But where should an individual investor go to gain the insights to construct an appropriate portfolio?

Numerous books will provide basic investment strategy and financial planning. Many of these books do a good job of giving investors an overview of the available investment alternatives, but few provide a clear and intuitive explanation of the asset allocation decision. In the widely regarded Bogle on Mutual Funds: New Perspectives for the Intelligent Investor (Dell, 1994), John Bogle does an excellent job of taking the reader through the process of selecting common stock, bond, and money market mutual funds. Of the 300-plus pages devoted to mutual fund investing, however, only 22 pages address asset allocation. Similarly, David Swensen's Unconventional Success: A Fundamental Approach to Personal Investment (Free Press, 2005) takes a thorough look at the mutual fund industry, but although Swensen devotes an entire section of the book to asset allocation, he focuses on which assets to hold as part of a core portfolio. He provides little discussion of how to construct an appropriate asset allocation or the benefits of doing so. Other books, such as Jeremy Siegel's classic Stocks for the Long Run (McGraw-Hill, 2002), use historical data to strengthen the argument for holding equities but offer no insight into the portfolio decision.

Those of us who have studied or taught courses in investments and portfolio management know that the textbook coverage of asset allocation is often restricted to a mathematical exposition of modern portfolio theory. These mathematical models, although elegant, tend to obscure the intuition behind the asset allocation decision for many students. In All About Asset Allocation, Richard A. Ferri, CFA, president and senior portfolio manager of Portfolio Solutions, LLC, attempts to bridge the gap between math and intuition by providing a readable discussion of this critical and often neglected aspect of investing. In many ways, Ferri is attempting to do for asset allocation what Peter Kennedy did for econometrics more than two decades ago in A Guide to Econometrics (MIT Press, 1985; first published by Martin Robertson and Company in 1979). Kennedy strove to strip away the mathematics of econometrics in order to provide a clear, intuitive understanding of this mathematically rigorous subject.

Although All About Asset Allocation is targeted to the less sophisticated investor, it should be valuable also to market professionals who counsel individual clients. The book contains many of the same graphs that can be found in standard texts, but because Ferri omits the mathematics that generate these graphs, the reader tends to focus on the concepts underlying the asset allocation decision. The intuition for asset allocation is further supported by numerous tables and charts of historical returns for various asset classes, in a fashion reminiscent of Siegel. Ferri also provides one of the more accessible discussions of the risk premium by stacking various types of risk premiums on the U.S. T-bill rate. In addition, Ferri presents a good review of behavioral issues in finance, issues that may be of value when communicating with clients.
Ideally, everyone with money to invest should be aware of the issues discussed in this book. Unfortunately, a book about asset allocation is unlikely to supplant investment books written by two brothers wearing court jester hats like the Motley Fools or a Suze Orman trumpeting the courage to be rich. The burden consequently falls on those who either work in the field of financial planning or are involved in training the next generation of financial professionals. They will find All About Asset Allocation an excellent tool for communicating to clients the importance of holding a well-diversified portfolio.
—R.L.M.

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