The next time I'm tempted to pontificate about asset allocation, diversification and rebalancing, I'd better explain what I mean.
I have made this resolve after perusing the latest in a series of investor-knowledge surveys by American Century Investments. For years, the company's highly focused surveys have consistently exposed a basic lack of understanding of investment terms and concepts by the U.S. public.
Most recently, a 10-question survey given to more than 680 Americans ages 18 to 41 found fewer than half understand the fundamental benefits of a well-diversified investment portfolio.
And fewer than 1 in 5 recognize the meaning of asset allocation, a term continually bandied about by investment advisers and the financial press.
In the survey, the question was: "Which of the following is true about asset allocation?" The choices were:
Asset allocation is a strategy where investments are divided among different asset classes such as stocks, bonds and cash.
According to academic studies, a portfolio's investment returns over time are based mostly on its asset allocation.
Asset allocation lowers a portfolio's risk because losses in one type of investment are offset by gains in others.
All of the above.
The correct answer? It is "all of the above," picked by only 14 percent of those between 18 and 26 years of age and by 18 percent of those 27 to 41 years old.
To their credit, 60 percent of the younger adults and 49 percent of the older group chose "don't know," suggesting they are more inclined to admit ignorance (but also to learn) than to try to guess.
"These generations are comfortable admitting that they don't know some of the basics of investing," said Donna Byers, an American Century senior vice president, but they are also "eager to learn."
To be sure, some purists will argue that the statements used to describe asset allocation are overly simplistic and not properly qualified. Others will insist that tangible assets such as real estate, precious metals and commodities should be included in the asset-allocation mix.
And I am not certain that everybody understands that a medium- to long-term bank certificate of deposit qualifies as a bond, just as a debt obligation from the government or a corporation does. Cash does not mean the money in your wallet or just your checking account balance, but is a generic term that extends to very short-term investments easily converted to cash, such as U.S. Treasury bills.
My plain-English definition of asset allocation is simply dividing your money into different types of investments consistent with the return you seek and the risk you're willing to take. The proper asset allocation leads to diversification, the proverbial not putting all our eggs in one basket.
Diversification reduces the overall volatility (ups and downs) of a portfolio because while one type of investment goes down, another may be going up. Another benefit, not mentioned in the survey question, is that diversification lowers the risk of a big loss.
Other recent surveys by American Century have found similar knowledge gaps. For example, only 13 percent of investors in 2005 understood the widely recommended practice of portfolio rebalancing. It simply means restoring a portfolio to its desired asset allocation by buying more of the types of investments that have gone down in value and/or selling some of those that have gone up. In 2001, investors flunked a questionnaire on bond basics, with less than a third understanding that bond prices fall when interest rates rise, and vice versa.
Humberto Cruz writes for Tribune Media Services.