ISSUE 143: Special Section

Know A Good Doctor? We Do.

Scott Neal

Scott Neal, CPA, CFP, is the president of D. Scott Neal, Inc., a fee-only financial planning and investment advisory firm with offices in Lexington and Louisville. Reach him at scott@dsneal.com or by calling 1.800.344.9098.

Let’s Review 2022 and Peer into 2023

Have you looked at your investment portfolio lately? I dare say that many of you don’t even want to go there. Rest assured that you are not alone. At the end of November 2022, for the trailing twelve months the S&P 500 Composite index had declined 13.6% and the tech-heavy NASDAQ 100 was down a whopping 29.3%. And get this— the Bloomberg Aggregate Government Bond Index was down 12.5% for the period.

The current market milieu is enough to cause a person to think about turning their portfolio into cash. For me, it called to mind a national conference that I attended in the early 90s. There, I heard Roger Gibson speak. The first edition of his book, Asset Allocation, had just been published, and he was making rounds through the lecture circuit promoting the tenets of Modern Portfolio Theory and the efficient market hypothesis. If you have read anything at all about investing over the past 30 years, you probably have heard it many times: diversify your portfolio into several asset classes, perform periodic rebalancing, and enjoy a smooth ride to retirement. “Don’t put all your eggs in one basket” is the folk version that is hard to argue with on its face. Out of

The key is that asset allocation works, until it doesn’t.

this theory, many, if not most, investment firms developed a typical “balanced portfolio” composed of around 40% bonds and 60% stocks. Let me do the math for you: the 40:60 portfolio lost 13.2% over the trailing twelve months mentioned above. Hardly comforting to most investors that I know.

Proponents of asset allocation usually advise that the bonds be spread among various maturities and/or various levels of credit quality. Stocks might get spread among companies of various sizes determined by capitalization of the company, i.e., large-cap, mid-cap, and small-cap. Some allocators will suggest adding some international companies and others will branch out into commodities and/or real estate. Having been taught the Benjamin Graham school of security analysis in grad school and perhaps being somewhat brash, I just had to put the question to Mr. Gibson, “How long before someone will be able to disprove this theory?” I recall that his response was something like, “At a recent CFA gathering in New York, it was the consensus of attendees that it would likely take 400 years of data to approach such a proof.” In other words, the leaders of the investment community suggested to not bother trying.

With improvements in technology around the turn of the century, a whole flurry of software tools sprang up to enable investment advisors and even lay people to easily optimize their portfolio around a targeted level of volatility and expected return. This led most people, including the asset management industry, to benchmark their portfolio return to the historical average of the S&P or even the 40:60 portfolio, rather than to their ability to pay for a goal like retirement, college education, or a particularly desirable standard of living.

Much has transpired over the years, but we still hear some version of this principal being trotted out as the panacea to market volatility. In fact, I recently visited an office of a brokerage firm and saw a sketch of the 40:60 portfolio illustrated on a white board. It is still alive and well. The key is that asset allocation works well, until it doesn’t. It is dependent on the lack of correlation between asset classes. You know the old saying, “When the tide goes out, we find out who is swimming naked.”

So, what is an investor to do? Attempt to time the market? Hardly. Unless, of course, you are clairvoyant.

The answer is to think more deeply about the systemic risks facing the various markets, and indeed our world, and to act more responsibly in addressing those risks. It requires systems thinking. Authors Jon Lukomnik and James P. Hawley have addressed one aspect of this in their new book, Moving Beyond Modern Portfolio Theory: Investing that Matters.

The authors will be dismissed by many as simply offering a political statement, because of their emphasis on environmental, social, and governance issues, dealing with both individual stocks and the portfolio taken as a whole. Taking a systems approach requires that we look deeply at how value is created and destroyed over time and our participation as investors in such creation and destruction.

On the turning of the calendar to a new year, is there any doubt that we are living through a significant liminal moment? Perhaps that could be said of nearly any age, but this one seems rather poignant to me. (Maybe that is because I am old enough to recall the details of a conference I attended 30 years ago.) If you haven’t already, it is high time to think outside the box and look beyond asset allocation as your investment strategy. Doing so an offer up a level of optimism that is hard to find this year. I have to say that I am truly looking forward to 2023 and I am optimistic that we can effectively deal with what comes next.


Scott Neal is president and CEO of D. Scott Neal, Inc., a fee-only financial planning and investment advisory firm with offices in Lexington and Louisville, KY. He will respond to your question or comment sent to scott@dsneal.com or 1-800-344-9098.