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Assess heuristic and other rule-based methods of setting an asset allocation

CFA® Level III · Asset Allocation · Principles of Asset Allocation · L3.AA.4.n

The idea

Simple rules are popular because they are transparent and easy to explain. The "120 minus age" rule sets the equity percentage by subtracting the investor's age from 120, ignoring wealth, human capital and goals. The 60/40 stock–bond mix is a long-standing balanced default. The endowment model allocates heavily to private and alternative assets to harvest illiquidity premiums, but needs a long horizon, size and manager access. Risk parity sets weights so each asset class contributes equally to total risk, which usually requires leverage on bonds and ignores expected returns. The 1/N rule equal-weights asset classes and, surprisingly, often performs competitively because it avoids estimation error. The trap is recommending a heuristic without checking it against the specific client's constraints.

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