Fibonacci Financial

Fibonacci Financial Portfolio Prism vs  Life-Cycle Investing

Life-Cycle Investing is a primary model for asset allocation in most financial planning performed in the U.S.A.  It is aptly described in a Social Security Policy Brief titled “Portfolio Theory, Life-Cycle Investing and Retirement Income”. The Policy Brief says “The life-cycle funds described here create portfolios that are heavily concentrated in stocks at the beginning of the work life and gradually shift holdings to bonds as retirement nears“.

The following table from the SS Policy Brief demonstrates this shift away from stocks as one ages:

This rigid/mechanical model relieves the Financial Planner of the burden of making market allocation decisions other than the fine tuning of these bench marks based on the clients special needs, goals, experience and expectations.  This model implies that intelligent decisions about asset allocation based on the markets is impossible.  Most Americans have bought into the Life-Cycle Investment  model as demonstrated by the next table which also comes from the same  SS Policy Brief.  Are you caught in the Life-Cycle Investment trap?  A first hint would be that your 401K is down 40-60%.

This table illustrates actual investor preferences as revealed in a study performed by Bodie and Crane (1997).

Remember – 90% of Portfolio Returns come from Asset Allocation decisions !

Therefore, if we get our allocations wrong it has tremendous impact on our wealth and retirement options.  Each quadrant (Cash, Lending, Investing, Tangibles/Intangibles) has its own seasons, cycles and dynamics.  Yes sometimes these cycles are correlated but sometimes they are not.

I will not explore the fallacies behind the stock portion of this model until a latter article.  But one chart will provide sufficient information to bring the “Bond” (aka Lending quadrant in FF Model) portion of the Life-Cycle Investment model into serious question. Vide !

Click to Enlarge

The above chart of 10 Year Treasury Bonds shows that there have historically been long periods of rising interest rates and long periods of declining interest rates.  Why should we care?  When interest rates rise the value of Bonds fall – ergo – you loose money!  When interest rates decline Bonds values go up!  As shown in the chart, interest rates have been declining for more than 25 years and as one would expect this was a period of rising bond values.  BUT interest rates are very low now.  Given past history, we are likely to see a 25 to 30 year period of rising interest rates begin in the near future – ergo – 30 years of losing money in bonds (except for a very few speculators).  These rising interest rates will devastate bond portfolios!  So, does it make sense to move older clients into this rising interest rate Bond Bear market trap? NO!, NO!, NO!

The Dynamic Fibonacci Financial “Portfolio Prism” Debut!

Without going into a complete explanation of the Fibonacci Financial portfolio development process, let me introduce the Portfolio Prism a dynamic approach to asset allocation.

The first step in the FF Portfolio decision process is to maintain an Asset Allocation Map of the market.  The result of our current assessment of the markets is displayed on the M.D.D. (Market Decision Dashboard).  The current recommended position in Bonds can be found in the “Lending Quadrant”.  Currently long term bonds are not under accumulation but are rather being liquidated in anticipation of a potential 30 year bear market in bonds.  But for illustration purposes, let pretend that Bonds are anticipated to be entering a 25 year bull market and will be under accumulation.  The next step in the FF Portfolio decision process would be to gather information about a client and to develop a client profile.  The final step would be to develop a portfolio based on the market profile and the client profile.  If bonds are deemed appropriate, regardless of the client’s life-cycle position, either conservative or more aggressive bond investment vehicles would be chosen.

The M.D.D. ( Market Decision Dashboard) in full display looks like:

(Caution the following view of the M.D.D. is for demo purposes only)

As a reminder, the underlined items in each quadrant will indicate that additional history, fundamental, technical and investing information is available when you click on the item and drill down.

So dear reader, should the aging Baby Boomers mechanically shift their decimated stock portfolios into bonds as recommended by a dominant portion of the financial planning community based on the static Life-Cycle Investment model ?

What do YOU think?  Please comment.

Feedback on the new Portfolio Prism would be greatly appreciated.