I wrote this article on October 19, 2011 on my Golden Valley Patch Blog.
I remember several years ago the day that I rushed back to my office with my first color printer. I could not wait to begin printing those beautiful multi-color pie charts for my clients. At the time, color pie charts were the pinnacle of timely investment management advice.
You know the pie charts I am talking about, right? You can always find a pie chart when you open up your company 401(k) account on your company retirement plan provider web site. The pie chart shows you how your company retirement plan account is currently invested in a mixture of stocks, bonds, and money market funds.
Every financial advisor in North America would be willing to show you, at your earliest convenience, how your investable funds should be invested now—in pie chart living color. This core investment management advice concept has not changed in a generation.
Fortunately for my current clients, I learned many stock market declines ago that the asset allocation assumptions shown in a pie charts don’t work very well when the stock market is going down.
First, pie charts can’t help predict what your investment returns will be in the future. All computer generated asset allocation programs are based upon historical investment returns. Pie charts are always based on the assumption that stock market investment returns will always be positive.
I guess pie charts are not programmed to have any memory of the last five years of negative investment return for the S&P 500 index.
Making future investment return assumptions based upon historical relationships is financially dangerous. As a current reminder, remember how the current generation of Baby Boomers always thought that real estate values would rise forever?
Second, pie charts don’t react to the most important investment management decisions that have to be made periodically in a company retirement plan account. Pie charts make no sense out of constantly changing world wide economic, political and stock market events.
Professional money managers can’t afford to rely on the theory behind pie chart asset allocation. Instead, these professionals make investment management decisions for their clients based on what is really happening in the financial world, instead of “what should happen” or “what has happened historically.”
Computers can’t predict the economic and stock market reactions to budget deficits, bank failures, recessions, real estate price depression, record unemployment levels and entire foreign governments defaulting on their debt. Humans have to make the investment management decisions in reaction to those events as they happen.
Third, pie charts can’t help you define or manage your investment risk level. The truth is the most company retirement plan investors have no earthly idea what their attitude towards investment risk is at any particular time.
The only thing that most company retirement plan participants would ever agree on is that after the stock market goes down in a big way, they always wanted to have taken less risk with their company retirement plan account than they actually did BEFORE the stock market went down.
So, pie charts can’t really do what they are advertised to do. The measure of how something works is a function of how well it is used, and pie charts are clearly used in the wrong way by most financial advice professionals.
They don’t make pie charts that guarantee investment returns, react to real world stock market price moves, and preserve company retirement plan principal in the early stages of a stock market decline.
Pie charts look nice coming out of a color printer, and they probably would also look great in 3D. But they can’t help manage the investment risk in your company 401(k) retirement plan account.
Ric Lager
Lager & Company, Inc.
