Predicting is difficult-especially about the future. So runs the old joke.

Difficult or not, though, predictions are necessary in the money game, and there's the rub.

It's tempting to think that a prudent approach to diversified investing relieves us of forecasting. Saying "no" to predictions is popular in financial planning circles, where the idea of peering into the future and then acting on the analysis is dismissed as market-timing. It's a reasonable view, but it's also a bit misleading.

Expecting to invest without forecasting is akin to planning a day of swimming and expecting you won't get wet. Every investment decision-or at least every reasonable investment decision-requires a forecast, an assumption, an expectation. The embedded bet on the future isn't always conspicuous, but it's there.

Asset allocation certainly isn't immune to this rule. Ultimately, there's a forecast behind every decision on how much to hold of this or that asset class and how to design the mix generally. The only question is whether the forecast is based on reasonable expectations, and that's where things get tricky.

Take the popular plan of crafting a strategic asset allocation and sticking with it through thick and thin, supplementing it only with periodic rebalancing back to the initial asset weights. It's a sensible strategy on the surface, one that sidesteps market timing in favor of a dispassionate plan for picking up risk premiums, much as if they were lying on the ground like acorns, awaiting collection. Yet so-called static asset allocation strategies are rooted in forecasting. These forecasts are arguably flawed, but they are forecasts nonetheless.

The rationale for static asset allocations are long-run historical returns-for example, the U.S. stock market's annualized 10% total return for the past 80 years, which investors use as if it were a window looking into future performance. Even if that held true in the long run-a debatable proposition-there's reason to wonder if it will hold over, say, the next ten or even 20 years.

Returns, after all, are volatile in the short run, a fact that's too easily overlooked when we rely on long-run history as a guide. Even the rolling-ten-year return for U.S. stocks has been something of a roller-coaster ride, ranging from an annualized 3% to nearly 18%. Waiting for salvation in the long run is a nice idea on paper, but as Keynes said, in the long run we're all dead. In the short term, meanwhile, stuff happens, as the current climate so painfully reminds.

The lesson is that the future looks different, sometimes radically different, depending on from where you are looking. If you ignore this fact while crafting your asset allocation, you're asking for trouble-for instance, if you built your plan in early 2008 while looking only at long-run historical results. Obviously, that design would be something less than optimal now.

Risk premiums appear to be stable over very long periods of time, but that's mostly an illusion if we adjust for the real-world time horizons of clients. In fact, these premiums vary through time, as a large and growing body of academic research and real-world evidence tell us. The only question is how best to manage money in a world where the premiums fluctuate. The basic answer is that investors shouldn't rely totally on static asset allocation strategies.

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