Asset allocation—a portfolio’s mix of stocks, bonds, cash, real estate and other asset classes—is the cornerstone upon which many investment decisions are made. Each investor’s approach to asset allocation is extremely important and individual. Not only does a portfolio’s allocation meaningfully impact risk and returns, but an appropriate allocation can greatly increase the odds that investors will meet their long-term goals. When contemplating asset allocation and appropriate portfolio diversification, we recommend that you consider three guidelines:
1. Rebalance:
Stick to your allocation guidelines unless material life changes occur. Investors tend to want to shift the “appropriate” allocation toward outperforming asset classes. But when stocks do well relative to bonds, the portfolio should be rebalanced, even though you may feel good owning more of the outperforming asset class. Over time, a disciplined approach to rebalancing can reduce volatility and improve risk-adjusted returns, while helping prevent emotional decisions. Your financial advisor should help establish percentage thresholds, then maintain the portfolio within those bands. At Haverford, we recommend setting bands of ± 5 percent of the target goal.
2. Don’t over-allocate:
Often, investment professionals have made asset allocation more difficult than necessary by introducing esoteric strategies that can be inappropriate for many investors while increasing returns only marginally. Heightened complexity increases the likelihood of an investor making poor choices when the going gets tough. Over-allocating may also increase fees, with no promise of improved returns. A Morningstar study showed that investment funds that allocate and tactically shift between asset classes underperformed a balanced portfolio of 60 percent in U.S. equities and 40 percent fixed income (Bloomberg Barclays U.S. Aggregate Bond Index).1
3. Remain Disciplined:
Stay the course; a proper allocation can be a security blanket during bear markets and reduces the inclination to “time” the market. Selling out of an asset class at the bottom is a classic mistake detrimental to long-term performance. During the 15 year period ending December 2020, missing the market’s ten best days would have reduced performance significantly, with a return of just 4.3% compared to the S&P’s total return of 9.9%.2 Another study showed that over the past ten years the actual returns experienced by investors significantly underperformed market averages.3 These returns are largely the result of investors’ attempts to time the market in lieu of a disciplined allocation strategy. An understandable asset allocation with defined long-term objectives should help an investor avoid such mistakes.
Haverford’s approach incorporates these guidelines to reduce risk and increase returns. We believe that the right mix of asset classes, rebalanced periodically, allows investors to “stay the course” and meet long-term objectives.
1: Morningstar.com “Do Tactical Allocation Funds Deliver? April 3, 2019 https://www.morningstar.com/articles/922123/do-tactical-allocation-funds-deliver
2: Putnam Investments, https://www.putnam.com/literature/pdf/II508-ec7166a52bb89b4621f3d2525199b64b.pdf
3: Dalbar 2020 Quantitative Analysis of Investor Behavior
