An Asset Allocation Puzzle: When is a Puzzle Not a Puzzle?

Abstract

In a recent article in this journal, Canner, Mankiw and Weil (CMV) argue that in general popular investment advice, and in particular the investment advice of four investment advisors, is inconsistent with modern portfolio theory and is irrational. As CMV state, since portfolio theory is so well known and easy to implement, finding irrationality here has serious implications for the assumption of rationality throughout economics. As part of their analysis, CMV assert that investment advice can only be viewed as rational if the ratio of bonds to stocks either remains constant or increases as the investor seeks higher return (takes on more risk). As evidence of advisor irrationality, CMV point out that investor advisors frequently advocate decreases in the ratio of bonds to stocks to obtain higher returns. They state, "Although we cannot rule out the possibility that popular advice is consistent with some model of rational behavior, we have so far been unable to find such a model."