Thinking Out of the Box, Literally: Introducing the Style Boxes

In an earlier post, I said investors and their advisors should be thinking out of the box right now, and I meant it literally. But it was industry insider lingo, so I'll explain it more in this post and the next one over the weekend. For now, let's meet the "style boxes".

Each investment style box represents a particular slice of the investment marketplace. Picture a tic-tac-toe board. The top boxes, if we're talking about stocks, are for the large companies. The top-left box is for large "value" companies. Top-right is for large "growth" companies. The top-middle box is for large "blend" companies.

The middle row is for the mid-size companies, the bottom row for small companies. And a similar board full of style boxes can be made for companies outside the U.S., in either "developed" markets or "emerging" markets.

Same story for bonds, but the categories are different: high, medium and low quality... short, intermediate, and long duration... government (aka sovereign), municipal, and corporate... domestic, developed-foreign, and emerging markets...

Okay, so what?

Well, a typical mutual fund or private portfolio manager invests pretty much in just one style box, or maybe a few very closely-related style boxes. Since different investment styles do better or worse at different times, it is important to either allocate your portfolio to the right long-term strategic mix of style-boxes or to be able to move out of the style boxes that are going to have difficulty and into to the ones that will do well, and then back again when conditions dictate.

In 2008, all but a few style boxes were bad places to be invested. Almost everything was going down, a lot. Even the best strategic asset allocations got hammered. There is Nobel Prize-winning research showing us how much to put in and keep in which style boxes for the long-haul, and it's valid. But it was very painful in 2008 to have stayed with a strategic asset allocation because you were deliberately staying put in style boxes that were plummeting.

It could be painful like that again sooner or later, given the fundamental economic difficulties much of the developed-world economies have right now.

So, next we'll talk about ways to think and move out of "the box(es)". It might be helpful.