But here are words of caution from recent history: Beware a strategy pitched as "absolute return" during mild markets that turn into relative return investments during bear markets (e.g., hedge funds that defend their poor recent performance by comparing the results to the S&P versus an absolute return benchmark).

As for tactical allocation, here I'm a bit more conflicted, as I do believe in the fundamental premise-namely, that markets and investment classes and styles move in cycles and that markets tend to over- and underreact over those cycles, eventually regressing back to "normal" relationships. The problem is determining and accurately timing those moves.

For someone who believes in the basic tenets of modern portfolio theory, the good news is that MPT and tactical allocation are not mutually exclusive. There are a number of ways they can live in harmony. For practitioners confident in their ability to consistently manage tactical movements, a solution may be to establish a strategic policy with tactical bands. The width of those bands is directly proportional to the advisor's confidence in his tactical decisions (i.e., the more confident he is, the wider the bands). For those unprepared to regularly "bet" the whole portfolio on their tactical view, fundamental changes in longer market views can be reflected in revisions to the strategic model. The advisor can make shorter term tactical bets by implementing a core-and-satellite strategy-in other words, a strategic core and a tactical satellite.

Beating Overconfidence
Even as professionals, we are at risk of overestimating our ability to predict the future (in fact, perhaps more so) because as humans we have a tendency to overestimate our competence, knowledge and experience and our ability to control outcomes. We tend to overestimate the information we have (which creates a knowledge illusion) and the accuracy of our estimates and our abilities (which create control and experience illusions).

I know how tempting it is to look for "the answer" to miserable markets, particularly as we suffer from the lost decade. But it is dangerous to ignore the behavioral risk of overconfidence as you compete against the thousand other Tiger Woodses in the global investment markets.

In 1938, John Durand wrote Timing: When to Buy and Sell in Today's Markets, one of the early classics in active investment management. He also wrote How To Secure Continuous Security Profits in Modern Markets, in which he opined: "As this is written, one of the greatest bull markets in history is in progress. People have been saying for several years that prices and brokers' loans are too high; yet they go on increasing. ... People who deplore the high at which gilt-edged common stocks are now selling apparently fail to grasp the fundamental distinction between investments yielding a fixed income and investments in the equities of growing companies. Nothing short of an industrial depression ... can prevent common stock equities in well-managed and favorable circumstanced companies from increasing in value, and hence in market price." This advice was penned September 1928.

In March 1998, Brad Barber and Terrance Odean, two respected behavioral finance academics, published a paper often referred to as "the cost of a good idea." Based on the trading records of 66,465 households with accounts from 1991 to 1996, the researchers compared the performance of the stocks investors sold to the performance of the stocks they bought with the proceeds of the sale. They found that those who traded most (i.e., those investors with the most "good ideas") earned an annual return of 11.4%, while the market returned 17.9%. The average household earned an annual return of 16.4%. Their conclusion? "Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth."

If you remember the "New Era," you probably remember the money manager Robert Markman. In March 1999 he wrote, "The asset allocation zealots are mindlessly over-diversifying based on past performance. Ironically, it is the asset allocation zealots, in their rush to mindlessly diversify, who are projecting dangerously from past performance." In April he wrote "Bubble? What bubble? An all-time high often means the market is going higher. A lot of people talk about this all-time high as if it's a market top. ... This market high is a reflection of a strong economy. ... This market is different from the market top of the '60s. This market is different from the market of the early '70s. This market is certainly different from Japan. A lot of people are pulling out the old Japanese bubble stuff, saying it'll happen here.

Let's keep in mind in the late '80s, when the Japanese market was truly a bubble, the ground of the Imperial Palace in Tokyo had a greater market value than all the real estate in the state of California. That's a bubble! This is the future-changing right in front of us. What we have are some pretty high P/Es that are based on expectations of future growth. Those who can't understand this market don't understand the role of technology in our economy and how it's changing right before our eyes."

I know you've all seen the charts: "If you missed the x best days," your return would have only been x%. That obviously begs the question: Why would someone miss those few best days? The answer is, the market moves up just as quickly as it moves down. According to one recent study, 70% of the best days in the market occurred within two weeks of a worst day (14 out of 20 days) and 100% of the best days occurred within six months of a worst day (20 out of 20 days).