Asset allocation is certainly no simple task, but it's a little easier for passive investors as far as choosing funds. The reason is that indexers aren't concerned with finding the best manager in an asset class - they simply invest in the index fund or ETF that covers the asset class and move on. However, there are some decisions to be made because there are usually several indexes that cover an asset class. To help sort things out a little, we went into Morningstar's index database and looked at ten-year returns and standard deviations of many popular indexes and listed them below by size (small, mid, and large).

Standard deviation tells an investor how widely the index returns fluctuated over the 10-year period. A higher standard deviation implies more volatility and risk.

Finally, here's similar data for two broad total market indexes, as well some numbers for a REIT index and an international index - the broad MSCI EAFE.

So there's some index data to chew on when you're making your asset allocation calls, although there are a few caveats. The first is that these numbers are based on past returns, and as such they're no guarantee of future results, as they say. However, many investors use past performance and volatility as a guide to form reasonable expectations when making portfolio allocation decisions. Using the past to extrapolate future returns is by all accounts a dangerous game, but many economists believe historical data is a little more useful in the context of quantifying risk and volatility.

It should be duly noted that the 1990s showed us one of the most exuberant bull markets in U.S. history, and the returns data above back that statement up. In other words, don't count on returns like this because history shows they are not the norm. Many respected economists and investors, including John Bogle, have said that a more realistic expectation for the return on equities over the next few years might be somewhere in the neighborhood of 6 percent annually.

Also, no investor should make asset allocation decisions based solely on asset class risk and returns, but we did think it would be nice to have that index data in one place for convenience.

Finally, ten years is a relatively short amount of time, but it's the best available through Morningstar. Luckily, financial advisor and discussion board denizen Jeff Troutner has similar data going back to 1964. The data is more extensive, but most of the numbers are based on DFA indexes, which currently aren't available to most individual investors.

03/07/2002

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