The Hierarchy of Investment Choice

Abstract

Which investment choice is most important? Is it allocation among broad asset classes, country allocation, choice of sector, or selection of individual securities? Many investors have a false impression of the relative importance of these choices for two reasons. First, investors fail to distinguish between the activities they choose to emphasize and those with the greatest potential to influence investment results. Second, to the extent that investors do measure the potential influence of an investment activity, they often base their choices on contrived portfolios that are unobtainable. Simulations including thousands of realistic portfolios help us determine the natural dispersion of performance arising from different investment activities, which makes it possible to evaluate the hierarchy of investment choice from a normative perspective.