In the world of finance, we are often buried under an avalanche of new research, each paper claiming a novel edge or a revolutionary finding. But every so often, a study emerges that is so foundational, so unequivocal in its conclusions, that it permanently alters the conversation. The 1986 study out of Brigham Young University, formally titled “Determinants of Portfolio Performance,” is one of those rare pieces of work. I return to its findings constantly, both in managing my own investments and in advising clients. Its core conclusion—that asset allocation policy is the primary determinant of a portfolio’s returns—is as relevant today as it was nearly four decades ago. But its message is also one of the most frequently misunderstood in all of personal finance. Today, I want to dissect this seminal study, explore what it actually said, and clarify the critical nuances that often get lost in translation.
The Study Itself: Laying the Groundwork
The study was conducted by Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower (often referred to as BHB), and later reaffirmed in a 1991 follow-up. Their goal was straightforward yet ambitious: to determine what factors explain the variation in returns of large pension funds over time.
They broke down the performance of these funds into three components:
- Investment Policy (Asset Allocation): The target allocation to major asset classes (e.g., stocks, bonds, cash) and the subsequent periodic rebalancing to maintain those targets.
- Market Timing: The deliberate decision to deviate from the policy allocation based on predictions of future market movements (e.g., moving to more cash because one believes a bear market is coming).
- Security Selection: The process of choosing individual stocks or bonds within an asset class (e.g., picking Apple over Microsoft, or choosing a specific corporate bond).
Their methodology involved analyzing the performance of 91 large corporate pension plans over a decade, comparing their actual returns to a passive benchmark portfolio that simply held their stated policy mix using index funds.
The Earth-Shaking Conclusion: Policy Overpowers Everything
The results were staggering and counterintuitive to many active managers at the time. BHB found that:
93.6% of the variation in a fund’s returns over time could be explained by its asset allocation policy.
Let me state that again. The long-term ups and downs of a portfolio’s performance were almost entirely dictated by the basic decision of what percentage to put in stocks versus bonds versus cash. The other two activities—market timing and security selection—collectively accounted for less than 7% of the variation in returns.
Furthermore, and this is a crucial point often missed, the study found that market timing and security selection did not, on average, add positive value. In fact, these activities typically detracted from returns after accounting for transaction costs and fees. The average pension fund would have performed better by simply adopting a static, indexed asset allocation and never deviating from it.
This finding is the origin of the now-ubiquitous pie chart that dominates introductory investment materials, showing asset allocation as the overwhelmingly dominant factor in performance.
The Profound Misinterpretation: What the Study Did NOT Say
This is where my expertise must interject. The financial services industry has, at times, wielded this study as a blunt instrument, leading to a widespread and critical misinterpretation.
The study did not say that asset allocation explains 93.6% of your total return or gain.
It said it explains 93.6% of the variation in returns over time.
This is a subtle but monumental difference. The study was about what drives the volatility and pattern of a portfolio’s performance, not necessarily the final dollar amount. For example, the decision to be 80% stocks/20% bonds versus 20% stocks/80% bonds will create two wildly different patterns of return (high volatility vs. low volatility). The BHB study found that this policy decision is the reason why the performance lines on a chart look so different.
However, the actual level of your ending wealth is also powerfully determined by the returns within each asset class. A 100% stock allocation will have a different ending value if the S&P 500 returns 10% per year versus 5% per year over the period. The asset allocation policy defines the mix, but the market’s performance provides the fuel.
The Enduring Implications for Individual Investors
So, if the study isn’t a magic bullet, what are the practical, actionable takeaways for you and me?
- Focus Your Energy on the Biggest Lever: The single most important investment decision you will make is setting your stock/bond/cash allocation. This decision should be based on your financial goals, time horizon, and—most critically—your ability to tolerate risk emotionally. Spend more time here than on picking the next hot stock.
- Market Timing is a Loser’s Game: The study provides rigorous, empirical evidence that attempts to outsmart the market by jumping in and out of asset classes are more likely to harm your performance than help it. This validates a core tenet of the buy-and-hold philosophy.
- The Case for Indexing is Strengthened: If security selection is not a reliable source of added value for sophisticated pension funds with teams of analysts, what makes an individual investor think they can consistently do better? The BHB study is a powerful argument for using low-cost index funds and ETFs to implement your asset allocation, as they eliminate the drag of poor security selection and high fees.
- Rebalancing is Your Secret Weapon: Since policy is paramount, the mechanical process of rebalancing—selling assets that have appreciated beyond their target and buying those that have underperformed—is the disciplined way to maintain your policy. It forces you to sell high and buy low, all while keeping your risk level consistent.
A Modern Context: Does the Study Still Hold Up?
The financial landscape has changed since 1986. We have new asset classes like cryptocurrencies, a plethora of complex ETFs, and algorithmic trading. Critics have published papers challenging the exact 93.6% figure.
However, the core principle remains unassailable. Subsequent studies, including one by Roger Ibbotson, have confirmed that while the exact percentage might vary, asset allocation is unquestionably the most significant decision under an investor’s control.
You cannot control the market’s returns (the “fuel”). But you have absolute control over your asset allocation policy (the “mix” or the “engine”). The BYU study’s enduring legacy is its powerful directive to focus on what you can control and to stop wasting energy, and sacrificing returns, on what you cannot.
Conclusion: Embracing the Wisdom of Simplicity
The Brigham Young University asset allocation study did not give us a complex formula for beating the market. Instead, it gave us permission to stop trying. It validated a simple, disciplined, and incredibly effective approach to investing:
- Define your target asset allocation based on your personal goals and risk tolerance.
- Implement that allocation using low-cost, broad-market index funds.
- Maintain that allocation through periodic rebalancing.
- Ignore the noise and the temptation to time the market or chase performance.
This is not a passive strategy. It is an active choice to focus on the few things that truly matter. It is the recognition that successful investing is a test of temperament, not intellect. The BYU study handed us the blueprint. Our job is to find the discipline to follow it.
