Finding the right portfolio balance

Investors can often get caught up in financial market drama, making it increasingly difficult to maintain a balanced portfolio. This article looks at the importance of balance and why we think regular rebalancing is key.

Balanced In Investment 17 08 22
Ben Seager-Scott
Published: 18 Aug 2022 Updated: 18 Aug 2022
Savings and investments IFAs

What an unpredictable year 2022 has been for investors so far. The loose monetary policy that supported bonds and equities reversed abruptly causing both to drop at the same time. Investors with high exposure to previously top-performing areas such as the technology sector or government bonds were hit particularly hard. This serves as a stark reminder of just how important it is to maintain balance within a portfolio.

A rare occurrence: equities and bonds falling at the same time

Underlining just how rare it is for equities and bonds to fall together, April 2022 was only the fourth month in 50 years that both the US stock market and US Treasuries were down at the same time. And June was the fifth month in 50 years.[1] This reflects the rapid shift to rising rates from the low interest-rate environment that has prevailed since the Global Financial Crisis.

Some parts of the market have been hit far harder than others. Those investors that maintain a diversified portfolio, spread across a range of asset classes, sectors and geographic regions are likely to have fared better in the recent rout. They are also more likely to have experienced a smoother ride over the long term.

Maintaining a balanced portfolio is harder than it looks

Investors often get caught up in the drama of financial markets ─ panicking in volatile markets, for example, or being lured by the excitement of more exotic, speculative investments. They may hang on to previous winners long after they are past their best in the hope that the market will turn, or keep high weights in top-performing areas in the expectation that their success will continue indefinitely.

This means it is easy for portfolios to become unbalanced even if they start out well-diversified. For example, many investors may have found themselves with significant weightings in technology after its recent strong run. While that may result in periods of strong returns, it makes for a volatile ride and some hair-raising short-term losses.

Could a balanced portfolio help mitigate against volatile markets?

Ensuring that a portfolio has a balance at all times brings an important discipline to investing. It encourages investors to sell out when prices are high and reinvest when prices are low.

For example, if a portfolio has 20% invested in the energy sector and strong performance in that sector saw that rise to 25%, it makes sense to rebalance that back to 20%. The alternative is that energy becomes a larger part of the portfolio: this can leave it poorly diversified and could potentially increase risk, leaving the portfolio more vulnerable to any change in market conditions.

While in theory it may be possible to time your exit from a particular sector - selling out when it looks like its fortunes are weakening - in practice, this is fiendishly difficult to do. Even professional investment managers, who are monitoring the market day to day and have abundant information at their fingertips, rarely attempt it. The market often anticipates change for individual companies and sectors ahead of time, which makes it tough to get ahead of it. A recent example was during the pandemic, when markets started to recover only weeks after the initial sell-off, even as most of us were just beginning to go into our first lockdown. We believe regular rebalancing can be a far more effective mechanism to manage the highs and lows of markets.

The emotional advantage to regular rebalancing

Being clear about the structure of a portfolio means that you aren’t worrying about the market highs and lows or whether it’s a good time to invest. An investor who knows what their portfolio should look like for the long term doesn’t have to worry about the day-to-day market mood.

What does a balanced portfolio look like?

It has become more complex to build a balanced portfolio in recent years, as the unusual monetary policy from central banks has distorted the performance of equities and bonds, and they have become more closely correlated. We see the market eventually reverting to more normal patterns of diversification now that the monetary policy environment has shifted. Therefore, we believe it is important to include areas such as commercial property and infrastructure, as well as maintaining a balance within each asset class – having exposure to corporate debt, for example, alongside government bonds.

We believe it is important to have an emotionally-independent third party in your corner, with the tools and depth of research to ensure a properly diversified portfolio that is resilient in a variety of market conditions. Asset allocation should be based on the fundamental characteristics of each investment and are tailored to your needs. At Evelyn Partners, our professional investment and fund managers do this on your behalf, setting an appropriate asset allocation and then ensuring that the portfolio holds that shape.

Sources

[1] GFD, Evelyn Partners, US Bonds: US 10 Year Treasury Index, US Equities: S&P 500

Important information

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

The value of an investment may go down as well as up and you may get back less than you originally invested.

Past performance is not a guide to future performance.

Funds which invest in specific sectors may carry more risk than those spread across a number of different sectors.  In particular, gold, technology and other focused funds can suffer as the underlying stocks can be more volatile and less liquid.

The property market can be illiquid; consequently, there can be times when investors will be unable to sell their holdings. Property valuations are subjective and a matter of judgement.

Bonds issued by major governments and companies will be more stable than those issued by emerging markets or smaller corporate issuers; in the event of an issuer experiencing financial difficulty, there may be a risk to some or all of the capital invested.