Personal Finance Essentials
The Power of Diversification
It’s Not About Picking the Right Stock, But About How You Distribute Your Investments
Across Different Asset Classes
The “Brinson study” is a landmark 1986 analysis in financial theory that found that asset allocation decisions, not security selection or market timing, account for most of the variation in a portfolio’s returns over time. The study, affectionately known in the asset management field as BHB because it was written by Gary Brinson, L. Randolph Hood, and Gilbert Beebower, is titled Determinants of Portfolio Performance.
This 1986 analysis examined the returns of 91 large U.S. corporate pension plans over a 10-year period and concluded that 93.6% of investment portfolio performance differences were due to asset allocation, not individual security selection. In other words, which stocks or bonds you pick doesn’t matter much. What really counts is how much of your money you place into each asset class. You could buy the right stock, but if you only invest 1% of your money in it, it won’t matter much even if it doubles in value.
Key Insight: It’s not about picking the right stock – it’s about how you distribute your investments across different asset classes.
What Asset Allocation Means in Practice
Asset allocation refers to how you divide your portfolio among the major investment categories: cash, bonds, stocks, real estate and international investments. Each of these behaves differently in different economic conditions. When stocks fall, bonds and real estate often hold their value or even rise. When interest rates change, different assets respond differently.
The goal is not to predict which asset will perform best – it is to spread your money across all major asset classes so that your portfolio’s overall performance doesn’t depend on any single one doing well. Investors who concentrate their money in a few “winning” assets tend to take on more risk without earning more return. Broad diversification, by contrast, reduces volatility while preserving the ability to build wealth over time.