This letter is the start of a process we will, in the future, develop into a more useful and practical asset allocation framework for investors’ portfolios that reflects our macro view, concerns about the general riskiness of the financial world and a variety of issues that go into the asset allocation process.

As a starting point, it is important to understand what real long-run rates of return have been for different assets.2  Good data exists on developed country equity markets by sector and on real estate.

For example, most people know that the real long-run return on U.S. equities is about 6.5%. Small-cap stocks outperform large companies by a wide margin, value stocks outperform growth stocks, also by a wide margin, and small value stocks easily outperform small growth stocks. However, small companies have much greater volatility and business risk.

It is also well known that the real return on bonds lags the real return on stocks, but risk is much less. In a portfolio, the inclusion of some bonds along with stocks lowers risk faster than it lowers returns up to a point.

…continue reading the 14 page Asset Allocation Thoughts

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