January 2009 Is Asset Allocation Broken?   Greetings! At Bristlecone, our core expertise is investing in equities. Although we've always been skeptical of certain investment classifications, we have long been advocates of diversification beyond the type of stocks that we typically invest in on your behalf.  Over time, the fluctuation in value of a diversified portfolio, or volatility, is typically lower than in a portfolio concentrated in one area of the market, because different portions will tend to excel or lag at different times, thus smoothing out the overall returns.   The most fundamental layer of portfolio diversification is via broad asset classes (stocks, bonds and cash). But investors should also diversify within asset classes across geography, industry sector, or company size. Used in combination, a well-diversified portfolio should include different types of investments, such as: large cap, small cap, and international equities, domestic and foreign bonds, or even real estate, natural resources, etc.   Yet the value of this advice was severely tested in 2008. As the table below illustrates, mutual funds investing in the most commonly used asset classes all declined sharply in 2008 with one exception: US Government bonds. Source: Morningstar Fund Category Returns - 2008                 Witnessing such painful returns across a broad investment spectrum has led some investors to question the wisdom of diversification. We believe that it would be a mistake to draw such a lesson from 2008, for several reasons.   For one, the appropriate mix (the asset allocation) within a portfolio is a function of an investor's tolerance for risk and time horizon. Investors who suffered the least in 2008 were those who had some bonds and cash in their portfolio. Such investors tend to be closer to retirement, already retired, or drawing income from their portfolio for one reason or another. For instance, a hypothetical investor who had allocated 25% of his or her portfolio to bonds and cash last year would have seen overall losses much lower than an investor who was 100% in stocks.   It would be wrong to conclude based on this most recent evidence, however, that you should allocate your entire portfolio to government bonds or cash. Remember that these very same investments have historically delivered among the lowest long-term returns. Once equity returns improve (and they will eventually), a portfolio with a 25% allocation to bonds and cash will most likely lag behind a portfolio invested entirely in stocks. Even people who are currently retired need to strike an appropriate balance between capital preservation (typically provided by cash and the safest bonds) and capital appreciation (mostly provided by equities). This is necessary in order to protect purchasing power from inflation throughout a retirement that could last as long as 20 to 30 years.   This being said, there is no question that diversification within equities was ineffective last year. All equity categories experienced negative returns in the 30% to 50% range. Unfortunately, this is not uncommon during periods of market upheaval .  Moreover, even if diversification fails during some shorter and particularly disruptive periods, this does not diminish its utility over longer-term periods.  Once markets recover, it is impossible to know which style or category will outperform or underperform, but history tells us that such patterns will occur and persist for potentially several years at a time.  For this reason, our opinion is that investors are better served by remaining properly diversified.   No matter how gut wrenching it is at times, most investors today need to take some risks by investing in equities in order to reach their financial goals. It is therefore critical to build a portfolio that is appropriately diversified and (just as important) regularly rebalanced. Rebalancing is particularly essential to ensure that, as markets or your situation change, you maintain an appropriate level of risk to meet your financial goals.   In response to client requests, Bristlecone launched a new Investment Supervisory Service (ISS) in early 2008 to address these needs. A number of clients have already signed up to seek our guidance on asset allocation, fund selection, and appropriate rebalancing during this turbulent time.  We believe this is a cost effective solution that can provide real value, so we encourage you to consider consolidating assets your assets with Bristlecone.   If you would like more information on this service or have any questions about diversification, please give us a call at (877) 806-4141.  We look forward to hearing from you and, as always, appreciate you being a client.    February 2009 Visit our website. THE FIRM NEWS/ARTICLES PEOPLE PHILOSOPHY HOW TO INVEST   Did someone forward you this message? 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