Musings on a Famous Portfolio Asset Allocation Study

Some Critics Claim Brinson, Hood, and Beebower Conclusions Wrong

[By Dr. David Edward Marcinko MBA CMP™]


Frequently, we hear the axiom that asset allocation is the most important investment decision, explaining 93.6% of portfolio returns. The presumption has been that once the risk tolerance and time horizon have been established, investing is simply a matter of implementing a fixed mix of stocks, bonds, and cash using mutual funds selected for this purpose. This axiom is based on a famous study by Brinson, Hood, and Beebower (BHB) published in the Financial Analysts Journal in July/August 1986. It is the stuff of most modern business school and graduate students in economics and finance.

Enter the Critics

One critic claims that BHB’s conclusions and the interpretation of their conclusions are wrong, stating that because of several methodological problems, BHB needed to make certain assumptions for their analysis to go forward. They assumed that the average asset-class weights for the 10-year period studied are the same as the actual normal policy weights; that investments in foreign stocks, real estate, private placements, and venture capital can be proxied by a mix of stocks, bonds, and cash; and that the benchmarks for stocks, bonds, and cash against which fund performance was measured are appropriate. The author believes that each of these assumptions can lead to a faulty measurement of success or failure at market timing and stock selection.

The Jahnke Study

William Jahnke claims that BHB erred in their focus on explaining the variation of quarterly portfolio returns rather than portfolio returns over the 10-year period studied. According to the study, asset allocation policy explains only a small fraction of the range of 10-year portfolio returns earned by the pension funds reported in the study. The author concluded that this discrepancy is caused by the effect of compounding returns. He adds that BHB were wrong to use variance of quarterly returns rather than the standard deviation. Use of standard deviation would reduce the often cited 93.6% to about 79%. Moreover, BHB did not consider the cost of investing, such as operating expenses, management fees, brokerage commissions, and other trading costs, which are more significant for individual investors than for the pension plans studied. Jahnke claims that excessive costs can reduce wealth accumulation by 50%.

Note: (“The Asset Allocation Hoax,” William W. Jahnke, Journal of Financial Planning, February 1997, Institute of Certified Financial Planners [303] 759-4900).


Finally, the author takes issue with establishing long-term fixed asset class weights. Asset allocation should be a dynamic process. Higher equity return expectations should in turn produce larger equity allocations, other things being equal.

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3 Responses

  1. On Diversification

    It’s been years since I took dance lessons, but as I remember it, an evening of dancing has an overall rhythm that’s separate from each individual song. A good band will vary the tempo of the dance by playing a variety of music. Too many slow songs; and dancers get bored doing one foxtrot or two-step after another. Too many polkas or fast jitterbugs, and half the crowd might end up a bit too literally “on the floor.”

    A dance band might play mostly country-western music, have a big band sound, or focus on oldies rock and roll. But no matter what type of music it plays, in order to be successful it needs to have a diversified repertoire.

    And no band would be invited back if it played nothing but novelty dances like the hokey pokey or the chicken dance. These might be fun for a few minutes, but nobody—except possibly a three-year-old on a sugar high—wants to do them over and over and over.

    Unfortunately, some investors use what we might call the “hokey pokey” method of investing. They follow the latest get-rich-quick guru or the ups and downs of the market just like dancers following the directions of the song. They “put their right foot in,” and then the minute the market goes down, they sell and “put their right foot out.”

    Those least likely to enjoy this type of dance are the ones who “put their whole self in” by investing everything they have in one company’s stock or one asset class. When the value of that investment goes down, as it’s bound to do sooner or later, they get scared and pull their “whole self out.” Usually this is just at the wrong time, about when the market is starting up again.

    The investment class where most investors go “all in” is U.S. stocks. The majority of portfolios I see are heavily overweighed here. U.S. stocks are just one out of ten different asset classes. If everything you have, or most of it, is in this asset class, you are certainly putting your investment eggs all in one basket.

    If a young doctor went “all in” just in stocks and never got out, they would probably be okay. Unfortunately, most investors can’t leave well enough alone. The downturns are usually too much to bear emotionally, so they try to time the market by attempting to sell when stocks are high and buy when they are low. That almost never works. By trying to time the U.S. stock market by going all in and then all out, you compound your anxiety and depress your investment returns.

    It’s even worse if inexperienced physician investors fall prey to scam artists and “put their whole self in” by speculating in dubious schemes that are more hocus-pocus than hokey pokey. Some of these scams are multi-level marketing programs, dubious limited partnerships investing in the scam de jour, and even going into what could be good investments like business or real estate. Whenever you go “all in” to an investment, there’s a high probability you’ve set yourself up for a nasty fall.

    Diversified investing is like pacing your dancing. When you have a mix of tempos and a variety of steps, you can enjoy the music for the whole evening. Once in a while, a galloping polka might make you a little dizzy, or you might get out of breath doing the twist. But, the next slow two-step will give you a chance to recover. With a variety of music, you’ll still be having fun at the end of the night.

    Rick Kahler MS CFP® ChFC CCIM


  2. Key benefits of a sound asset allocation strategy include:

    1. Reduced risk: An appropriately allocated portfolio produces lower volatility, or a lower fluctuation in yearly return, by simultaneously spreading market risk across numerous asset class categories (i.e. stocks, bonds).

    2. Steady returns: By investing in a mixture of asset classes, you can advance your chances of participating in market gains and lessen the blow of poor performing asset class categories on overall yearly results.

    3. Meeting long-term goals: A diversified portfolio is designed to assuage the need to constantly adjust investment holdings to chase market trends.



  3. Asset Levels

    Definition of Level One, Two and Three Assets.



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