Podcast Summary

The Rational Reminder Podcast — Episode 343
How to Choose an Asset Allocation
Hosts: Benjamin Felix, Cameron Passmore, Dan Bortolotti
Date: February 6, 2025

Episode Overview

This episode provides an in-depth discussion of how investors should choose their asset allocation—a decision that heavily impacts investment outcomes. The hosts explore frameworks for understanding risk, the interplay between psychology and investing, and why both traditional and less-conventional risk measures matter. They address behavioral finance, practical risk profiling, the effect of time horizons on asset mix, and the challenges of optimizing portfolios beyond the basics. The aftershow follows up on recent community controversies and discusses the acquisition of PWL Capital by OneDigital.

Key Discussion Points and Insights

1. Asset Allocation: The Critical Decision

• Asset allocation is the most important determinant of investment returns.
• It’s not just about maximizing returns, but also about matching risk with the investor’s profile and needs.

  "Choosing an asset allocation...is one of the most consequential decisions that every investor has to make. But how do you figure out how much risk you should take?" — Benjamin Felix (05:07)

Framework Used:

John Grable’s Risk Profile Framework, including:

• Behavioral Loss Tolerance: Your ability to emotionally withstand losses.
• Ability to Take Risk: Objective financial capacity to accept losses.
• Need to Take Risk: The amount of risk required to reach goals.

2. What is 'Risk'? Beyond Volatility

• Risk is commonly defined as volatility, but the hosts stress this is often a deficient definition.
• Long-term risk also includes the risk of not achieving goals (shortfall risk) and losing purchasing power to inflation.

3. Behavioral Loss Tolerance

• Detailed as the central, limiting constraint on asset allocation.
• Often overestimated by investors, especially those with little experience.
• Six elements per Grable:
  • Risk Tolerance
  • Risk Preference
  • Financial Knowledge
  • Investing Experience
  • Risk Perception
  • Risk Composure (real-world behavior during market declines)
• Practical points:
  • Assessing risk tolerance using psychometrically valid questionnaires.
  • Most people are "average" in risk tolerance, not extreme.

"At the end of the day, doesn't matter what your ability or your need is. If you don't have the stomach to tolerate volatility...that's gotta be the limiting factor." — Dan Bortolotti (08:04)

• Notable Example (13:15):
  Discusses clients’ reactions during market crashes, highlighting the difficulty in acting rationally under pressure, even when one thinks they're prepared.

  "Historical investment returns are easy to observe and difficult to capture." — Mark McGrath (12:12)

4. Ability and Need to Take Risk

• Ability: Depends on time horizon, liquidity needs, and capacity for financial loss (including factors like insurance and employment stability).
• Need: Based on the required rate of return to meet goals; the advice is to take as much risk as needed, but no more.
• Balancing these means that even wealthy investors don’t necessarily benefit from greater risk if their goals can be met safely.

"You should take as much risk as you need to, but no more." — Dan Bortolotti (31:04, quoting Larry Swedroe)

5. Risk at Long vs. Short Horizons

• Over long time horizons, stocks become less risky (due to negative autocorrelation), and bonds can be riskier (due to positive autocorrelation and inflation risk).
• New research (Sederberg et al., 2024 CFA Institute) suggests optimal long-term portfolios for retirees may have more stocks than previously thought, though only if the investor’s behavior can handle it.

"For long term investors just need to understand how risk changes from a short horizon to a long horizon." — Benjamin Felix (36:59)

6. Committing to an Allocation: Behavioral Constraints

• The optimal portfolio is meaningless if investors can’t stick with it during downturns.
• Reaction to market swings is a major source of return drag.
• Adjusting asset allocation after realizing one's true tolerance is valid—but only as a long-term change, not a tactical market-timing shift.
• Risk is not only about market volatility but includes the possibility of not meeting your goals (e.g., running out of money in retirement).

"Behavioral loss tolerance as a binding constraint on asset allocation. So if your behavioral loss tolerance says you can't be more than 60% equity, ...it is constrained by behavioral loss tolerance." — Benjamin Felix (27:21)

7. Compensated vs. Uncompensated Risks

• Increasing returns should be done by taking compensated (systematic) risks: e.g., more stocks, factor tilts, diversification.
• Avoid large bets on single stocks, industries, or lottery-like assets—those typically result in lower expected returns.
• Leverage and asset class tilts have their own tradeoffs.

8. Handling “Perceived” vs. Economic Risk

• The “illusion” of safety (ex: GICs, private assets marked infrequently) can improve behavioral outcomes even if it’s not true economic safety.
• Harnessing such illusions may be rational for some investors.

"If you can accomplish that goal with an illusion, you've still accomplished the goal. Maybe you're doing the right thing for the wrong reasons, but that's okay." — Dan Bortolotti (50:43)

Notable Quotes & Memorable Moments

• "You can say you can handle a 50% decline in your investment value, but until you've actually lived through it, it's pretty hard to know." — Andrew Hallam (via Ben, 15:42)
• "It's pretty hard to argue against anything other than 100% equity portfolio. The problem is neither of those two things are true for anyone." — Dan Bortolotti (38:49)
• "Nothing like price to change sentiment." — Mark McGrath (26:35)

Key Timestamps

• 05:07 — Introduction to the main topic; importance of asset allocation
• 07:19 – 18:13 — Behavioral loss tolerance, practical stories, risk profile assessment
• 27:21 – 32:51 — Constraints: Ability and need to take risk; their interaction
• 33:04 – 40:00 — Long-term vs. short-term risk, longitudinal research on allocation
• 47:40 – 52:45 — GICs and the psychology of “guaranteed” stable value, volatility laundering
• 53:04 – 60:04 — Aftershow: Listener controversy over passive investing and “optimization”; the “last mile” of portfolio tweaks
• 62:06 – 74:56 — Reaction (pro and con) to PWL's acquisition by OneDigital; host Ben’s personal health update and its impact on perspective

Aftershow Highlights

Listener Controversy on “Optimization”

• Community pushback about the merit of optimizing portfolios further after getting the basics right.
• Hosts clarify: Not ignoring returns, just skeptical of much additional, reliable benefit beyond evidence-based investing (global diversification, low cost, discipline).
• Analogy: Chasing optimal nutritional advice—can become ever-changing, and the basics do most of the work.

"Don't be dismissive of people who say I'm going to have a merely outstanding portfolio instead of an optimal one." — Dan Bortolotti (55:08)

Acquisition by OneDigital: Reactions & Rationale

• Mixed reactions—some excitement, some skepticism, some fear PWL will lose its identity.
• Hosts explain: Decision made with extensive due diligence, no planned cutbacks, continued investment in client experience, and improved stability and succession.
• Ben: “It was not like we just did the thing one day because we felt like it.”
• Client trust seen as central (“Are you feeling good about this?”).

Personal Health Update

• Ben shares his recent cancer scare and surgery, underscoring the importance of health over wealth.
• Urges listeners: “Listen to your body”; acting early was likely life-saving.

"Money is a tool...but if you don't have your health, what does it actually do for you?" — Benjamin Felix (72:06)

Final Takeaways

• Asset allocation is about matching investments with both your financial objectives and, crucially, your behavioral realities.
• Risk isn’t just volatility; time horizon and inflation matter, and so does your capacity to stay the course.
• Taking compensated risks in a disciplined, evidence-based way is the core of sensible investing.
• Optimization is admirable, but most advances come from doing the basics well—and sticking with them.
• Personal experiences can reframe even the most disciplined financial planning.

Next Episodes:

• Guest interview next week
• AMA episode following week

This summary is designed to give both new and loyal listeners a clear, detailed account of the episode’s discussion, nuance, and direct advice.