Are you a well-balanced investor?
September 28th, 2013
By now most people will be acutely aware of the ups and downs in the investment markets, (particularly since the financial crisis unfolded) and the impact volatile market conditions can have on their investment portfolio. For many people it seems to make sense that those investments that are falling should be sold (in order to minimize any further losses) and, conversely, that the most attractive investments to place money in are those that are rising in value.
Unfortunately this sort of behaviour goes against the grain of how investment decisions should ideally be made as essentially you will always be buying when prices are high and then ‘cashing out’ at a loss. To really make money you should be buying investments when they are cheap and selling when they are expensive, however, even the most experienced investor will struggle to time the markets accurately.
So what is the answer?
A key strategy is of course to spread your investment across a range of asset classes (e.g. cash, equities, bonds, property etc) so that you have a diversified portfolio and are spreading your risk. However, over time the shape of an investment portfolio will change from its original asset allocation due to each asset class performing differently and your long term returns can be heavily influenced by whether or not the portfolio is periodically ‘reset’
Let’s assume that we have a relatively simply portfolio split 50% shares and 50% fixed interest (bonds) and that the returns on each asset class for the next 3 years are as follows:-
|Yr||Shares (50%)||Bonds (50%)|
The table below shows how the different performance of each class each year changes the actual percentage of the portfolio invested in each area at the start of each year should the portfolio not be ‘rebalanced’
The last step is then to calculate the returns in each scenario based on the amounts allocated to each type of investment at each stage during the term. As you can see below two portfolios that started life identically can produce quite different returns depending on whether they are ‘rebalanced’ to the original asset allocation model.
The actual benefit of rebalancing depends to a degree on how asset classes behave in relation to each other or, to use the correct terminology the degree of ‘correlation’ between them. In reality this simply means how two different investments (or asset types) move in relation to each other.
Asset allocation, although not the only factor, can be a significant influence on the overall returns from your investments. It is also important to remember that asset allocation is one factor which determines the overall risk profile of your portfolio and it is therefore important to ensure that your investments are regularly reviewed and consideration given to whether any changes need to be made to ensure that your investments are adequately diversified.
Please feel free to contact us if you would like to arrange for an investment review or if you require any advice or guidance on the above issues.
The value of investments can fall as well as rise and you may not get back the full amount invested.