Brokerage Firm Ads May Establish Standards for Asset Allocation and Diversification of Your Portfolio

rokerage firms (such as Salomon Smith Barney, Morgan Stanley, Prudential Financial, and Merrill Lynch) continue to promote their services in advertisements. These ads contain general principles that brokers need to know, and implement, such as monitoring customer portfolios and discouraging certain trades that would be unsuitable for their customers.

However, other ads issue rather precise guidance as to asset allocation and diversification, as well as the related concepts of rebalancing and market timing. Of course, the more precise the advice, the more customers will rely upon it in filing securities arbitration claims to recover their losses. The strong upward trend in arbitration filings, incidentally, should keep pace with what we believe will be the continued strong upward trend in brokerage firm advertising.

Let's start with diversification. We have seen an outpouring of advice from firms with respect to this topic. For example a major brokerage firm provides the following "Guidelines for Diversifying the Stock Portion of Your Portfolio":

8 to 25 stocks in at least 6 to 8 sectors with different investment characteristics;

No more than 25% of the total portfolio value in any one industry;

No more than 15% of the total portfolio value in any one stock; and

A minimum of approximately 3% to 4% of the total portfolio value in each security.

These guidelines, the firm states, "are not set in stone but should provide a starting point". But brokers who stray from these guidelines should be prepared to defend themselves.

Second, we see an outpouring of advice by brokerage firms as to asset allocation. Although asset allocation recommendations are not new, what is new is the extensive degree to which brokerage firms are circulating the asset allocation recommendations among the investing public.

The asset allocation recommendations vary widely. For example, consider the asset allocation recommendations of the same major firm that distributes the diversification guidelines noted above. For asset allocation, or "Strategic Asset Allocation Guidelines", as the firm phrases it, "aggressive growth" (highest risk category) investors should have the following allocations in their portfolios:

40% large cap stocks, 20% mid cap stocks, 20% small cap stocks, 15% in foreign developed stocks, and 5% in foreign emerging market stocks.

By comparison, another major national brokerage firm provides this "hypothetical" guideline for its "very aggressive" (highest risk category) investors:

10% high yield bonds, 10% balanced (common stocks and investment-grade bonds for long term growth), 20% large cap growth, 20% mid-cap value, 20% international, and 20% aggressive growth (stocks of smaller, rapidly growing companies for long-term appreciation).

Accordingly, brokers need to pay attention to what their firm, and what other major firms, suggest for asset allocations. They also need to remember that most customers have markedly more conservative investment objectives, which of course would require much more conservative asset allocations.

Moreover, to maintain appropriate diversification and asset allocation, brokerage firms also promote "rebalancing" of investor portfolios. One firm describes rebalancing as a "classic investment discipline". The firm suggests that rebalancing should be done quarterly or regularly, and notes that rebalancing "generally reduces volatility for your portfolio".

Finally, market timing is discouraged. Studies show that market timing nearly is impossible to do correctly over any considerable period of time. One firm displays the popular study that examined the 50 best days in the stock market between 1982 and 2000. That study found that if an investor missed the 50 best days, the annual returns would be reduced from 13.3% to 3.7%.

Most brokers know that they should asset allocate, diversify, rebalance and avoid market timing. Investors should make sure that their brokers know, and implement, these investment principles.