Book Review: The Intelligent Asset Allocator

There are two kinds of investors, be they large or small: those who don't know where the market is headed, and those who don't know that they don't know. Then again, there is actually a third type of investor--the investment professional, who indeed knows that he or she doesn't know, but whose livelihood depends upon appearing to know.
- William Bernstein, "The Intelligent Asset Allocator"

I used to be the second type. When I first started investing back in my second year in college, stocks were the only investment that I knew and stock price was the only thing I considered. Since I had only $600 to play, I wanted to buy a stock with price below $5.00. My logic was that it would be easy for $5.00 to jump to $10.00. Plus, how much further a $5.00 stock can drop? Though by luck, the stock price indeed jumped close to $10.00 after 6 months, and I indeed sold them to secure the profits, there were two fatal flaws in my thinking:

1. Diversification never occurred to me.
   
2. I was gambling, not investing, for the first characteristics of investing is to aim for the long term.

These two points are well addressed in the book "The Intelligent Asset Allocator," not only Author Bernstein tells you why diversification is vital by showing statistics, which was convincing to me, a math major, he also make suggestions on how to do it and what one should consider when doing it. Not only he points out the danger of the gambler's thinking, he goes further by suggesting that even thinking in terms of "recency" should be avoided. The book held in my hands was published in the year 2000, 3 year earlier than the time I made my first trade. Yeah, I could have read it if I were to do some research before jumping into the market. But it is not too late to read it now, and here are some key ideas from the book that got me re-think about my current asset allocation for my Roth IRA: (I haven't opened the IRA account yet due to the liquidity of my money. Patience is indeed a virtue.)

1. Invest on index. (Graham made the same argument in his famous book "The Intelligent Investor")
2. Dividing portfolio between uncorrelated assets. (This is not something that I considered in my asset allocation, for example, I don't have real estate or precious metal funds in my portfolio.)
3. Favor short-term bonds (of six months to five years) as your "risk diluting" asset, rather than long-term bonds. (This is something I considered.)
4. Beware of recency, and do not be overly impressed with asset class returns over periods of less than two or three decades. (This got me re-think about Dodge & Cox funds)
5. never increase your allocation to an asset because of economic or political events or because you have heard an analyst make a convincing case for doing so. (Once you are settled on a target, then you are set. I'm glad that I'm not settled yet, and so far, the only investment vehicle I have is my 401k, which I don't think significant changes needs to be made.)
6. When allocating your money, think all your accounts as a whole. (I had this idea before as well since the final goal is to measure how well your overall net wealth is doing, but I realized it would hard to re-balance such an overall portfolio as well. Mr. Bernstein recognized this as well. I guess the only solution is to give it a try and see how well it goes.)

Stay tune for my updated asset allocation.