Buy-and-Hold and Constant-Mix May Be Better Allocation Strategies Than You Think

Abstract

Given mean-reverting equity and interest rate uncertainty, this article shows a relatively low economic cost of using a simple allocation strategy, buy-and-hold or constant-mix, instead of optimal reallocation. Moreover, given the decision to use one of the simple allocation strategies, the article identifies (1) which investors will be better off with buy-and-hold than with constant-mix, and vice versa, and (2) which investors will be better off with a horizon-maturity fixed-income position than with a sequence of short-maturity ones, and vice versa. The article uses illustrations in a three-period binomial model to bridge the academic/practitioner gap and provide useful insights to those interested in applied investment management.

TOPICS: Portfolio management/multi-asset allocation, portfolio theory, portfolio construction

Key Findings

• • Given mean-reverting equity and uncertain interest rates, investors sacrifice little in expected utility by replacing the optimal reallocation strategy with a simpler allocation strategy of either buy-and-hold or constant-mix.

• • Traditional investors, with positive allocations to both equity and fixed income, are better off with constant-mix than with buy-and-hold and with allocating to a horizon-maturity fixed-income instrument rather than a sequence of single-period fixed-income instruments.

• • More risk-tolerant investors with levered equity positions are better off with buy-and-hold than with constant-mix and with levering by a sequence of single-period fixed-income instruments instead of a horizon-maturity fixed-income instrument.