Investing: focus and avoiding the frivolous

I'm in the middle of making my through David Swensen's book Unconventional Success. It's a very insightful book written in a repetitive clinical style with an surly attitude towards financial swinders, which includes all high-fee investment vehicles. Once you have a decent understanding of investment basics, I strongly recommend you read it.

I'll summarize different parts of the book over time, but for now I was struck by his assessment of where return comes from. Note that in return you can choose to tradeoff safer/less return versus riskier/more return.

1. Asset allocation dictates almost all of your return. This means choosing what fraction of your money is in stocks (broken down into domestic, international, emerging market), US govt obligations(Treasury bonds and Treasury Inflation Protected Securities (TIPS) and real estate. In case this wasn't clear: this is where you should be putting almost all your investment effort. The good news is that this is a hard problem with no obvious answers so you can't really spend more than an hour or two every so often (say every 6 or 12 months) and you just have to make a decision. The other good news is that I don't think your return is too sensitive to minor perturbations in your asset allocation, so you can be somewhat relaxed about it.
   


2. Market timing is at best ineffective. Namely trying to determine when to buy/sell certain asset classes (e.g. load up on foreign stocks, now) is at best ineffectual for the professionals and quite often disasterous for the individual. Individuals get greedy and often chase performance, namely putting money into hot assets which historically is the worst way to choose your assets. The recent US stock market bubble in 2000 is a good example. US stocks in general and tech stocks in particular were particularly hot, giving irrationally large returns. Many people who don't normally invest in the market, finally decided to hop in, essentially doing market timing, and got burned.
   

   Early on after the 1987 crash, I did realize I could not time the market in the broadest sense, by deciding on cash versus stocks. I recall pulling out of the market after continued losses only to watch it rise above my pullout level when I least expected it. So I've always stayed fully invested, but I've done performance chasing putting money into hot mutual funds and my returns suffered. The darn Kauffman fund (KAUFX) in the 1990's was my personal return killer. I've learned my lesson over time.
   

3. Security selection has a minimal role in return. This means deciding which stock or mutual fund or ETF or bond to buy/sell. This is typically where most casual investors spend their time, because they feel like they can analyze the various options and make an informed decision. Yet, there is surprisingly little benefit from doing this. Choosing your own stocks is essentially like running your own mutual fund, and historically mutual fund managers haven't beaten the market, despite having a lot more resources than you or I.
   

   A new game is to find the right super low-cost low-turnover, low capital gain index funds or ETFs to cover your asset allocation. It is appealing as you can evaluate largely comparable quantities such as management fees, turnover and asset breakdown. But don't be fooled, as this does not really buy you much.
   
   

So if you're interested in improving your returns, think about asset allocation and try not to spend too much time on security selection as tempting as it may be.

My current thinking for an aggressive stance is:

40% US, 30% foreign, 10% emerging, 15% real estate (domestic and foreign), and 5% cash/money market/T bills.

Swensen repeatedly gives the allocation: 30% domestic, 15% foreign, 5% emerging, 20% real estate, 15% T bonds, and 15% TIPS. And he's done exceptionally well (15+% annualized return with moderate risk. Wow.) over the last 20 years managing the Yale Endowment, so don't dismiss his views too easily.