Flawed Thinking behind the Asset Allocation Fund

An asset allocation fund is a type of mutual fund that attempts to diversify a portfolio for an individual investor through one simple fund purchase. Essentially, this type of fund will purchase a wide array of securities, spreading risk across the market instead of concentrating in one area. The goal is to give an investor a one-stop shop but still allow an investor to diversify, reducing the amount an individual needs to think about the types of assets he or she is holding. While the goal is noble, there is flawed logic in this model.

Lack of Specialization

All mutual funds have a manger or group of managers. These individuals are responsible for directing the fund's investments, and they do so through experience, training, research and even instinct. Most fund managers have a specialty. They are perhaps successful with commodity market investment, bond options or even currency exchanges. It is rare to find a manager who is a true "jack of all trades." Ultimately, there is someone who could outperform the manager in each specific area. Basically, as an investor, you are settling for second best. You are diversified into the bond market, but you are not dealing with the best manager in that market. You may see better returns by going through the effort of seeking the best in each individual category, ultimately finding higher and more stable returns in addition to spreading your risk.

Lack of Attention to Individual Goals

A fund is a fund no matter how you cut the cake. When you are involved in a fund, there is a certain amount of individual concession to be made in exchange for the good of the group. On the one hand, this benefits each investor. The fund can take part in institutional trading, engaging in derivatives or areas of the market not accessible to the individual. On the other hand, the individual will always be of lesser concern to the fund than the group as a whole. While your manager is attempting to meet the need the fund has for diversification, the needs you have for diversification can be tossed aside. 

Lack of Actual Diversification

When you invest in shares of only one fund, it can be highly diversified, but you will still be localized. If the fund has a bad year, you will have a bad year. Asset allocation funds attempt to overcome this, spreading the risk so wide that a bad year is almost impossible. However, it does occur. Even if there is no loss, the fund will rarely beat the market as a whole. In fact, the fund is like a snapshot of the entire market. If the market is down, there is opportunity for gains in a small area, but you will not be able to access that area as part of an allocated fund. You will be down with the rest of the market. If the market is up, you will post gains fairly consistent with the growth on a whole, missing out on opportunities for rapid wealth building. 

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