Risk Parity Resources: Gibson (2004)

Asset Allocation: Balancing Financial Risk (4th Edition)

Read the original (though this links to the more recent edition, published in 2013):

Asset Allocation: Balancing Financial Risk, Fifth Edition: Balancing Financial Risk, Fifth Edition: Gibson, Roger: 9780071804189: Books: Amazon.com
Asset Allocation: Balancing Financial Risk, Fifth Edition: Balancing Financial Risk, Fifth Edition [Gibson, Roger] on Amazon.com. *FREE* shipping on qualifying offers. Asset Allocation: Balancing Financial Risk, Fifth Edition: Balancing Financial Risk, Fifth Edition

Important Points for the RP Investor:

This book straddles a nice line: clear and straight-forward enough to be of use to DIY investors, thorough and substantive enough to be valuable for professionals. The target audience is investment advisors but is written more accessibly, as if Gibson’s goal is to help advisors talk with their clients about these topics in plain English. I read it first in the early 2000s (must have been the third edition), and quickly devoured it. It became an influential text for me, along with Burton Malkiel’s Random Walk Down Wall Street. You can see the early influences for me: a preference for index funds, an orientation towards the Efficient Market Hypothesis, and, with Gibson’s book, an insistence on diversification. Looking back on it, this was the fountainhead of Risk Parity for me, before I knew the name.

Gibson’s goal is to create a practical overview of asset allocation. He writes that the book will “draw on and explore the concepts of modern portfolio theory for the purpose of enhancing the conceptual understanding…but my emphasis will be on the practical implications of these theories” (page 6).

The whole book is well worth it for RP investors, but it is rather long (~350 pages), so if you just wanted the core of the book, I’d focus on:

  • The introduction and chapter one, “The Importance of Asset Allocation”:  Gibson lays out the basic concepts and previews the arguments of the book.
  • Chapters Two and Three: Gibson focuses on US stocks and then alternatives to US stocks in these two chapters, giving the reader a sense of how different asset classes have performed over time. Helpful for grounding the reader in later discussions of how the different asset classes  can be combined.
  • Chapter Six covers basic concepts related to portfolios: risk, volatility, and portfolio balance. For investors who have maybe heard briefly of these concepts but without much depth, this chapter is well suited and provides a framework to think about portfolios.
  • Chapter Seven is a deep dive into diversification, and includes a great explanation of correlation. Helpful here is Gibson’s visualizations of different portfolios with differing levels of correlation between asset classes.
  • Chapter Nine makes the case for the “Rewards of Multiple Asset Class Investing.” As explained in an earlier blog post, there is a great chart here that makes an intuitive case for diversification.
Visualizing Diversification
Regardless of the investing environment, diversification can help lower total portfolio volatility and stabilize, or even increase, returns. This wonderful illustration demonstrates just how important diversification is and what impact combining multiple asset classes can have in your portfolio.
  • Chapters Eleven, Twelve, and Thirteen can be skipped if needed, since they are directed towards professional investment advisors, but, if you’re game, they contain a helpful process for being your own financial advisor. Gibson creates a ten-step process for clients to walk through with their financial advisors, but they are written in a way that can be helpful if you just use them as questions for yourself.
“The most important message of this book is that broad portfolio diversification among multiple asset classes in the long run will deliver letter volatility-adjusted returns than traditional approaches that utilize fewer asset classes” (page 285).

From my perspective, one thing missing from the book is any mention of Risk Parity, though the book is decidedly RP-adjacent. It goes over many of the same topics: diversification, use of  multiple asset classes, correlation, and avoiding market timing and individual stock picking, and in its entirety reads as an argument in favor of the RP worldview. In a few places, Gibson mentions the need to prepare a (lower case) “all weather” portfolio but never mentions an “All Weather” portfolio, Ray Dalio, or Risk Parity more broadly.

In all, a great and helpful book, especially for individual investors who are beyond the basics level and want something meaty, but not something so technical and narrow as are many publications for professionals. Readable, relatable, and thorough, Gibson’s Asset Allocation belongs on every investor’s bookshelf.

Other Resources Related to this Paper:

Gibson is Founding Partner at Gibson Capital in Pittsburgh, Pennsylvania.

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