How to Reduce Risk with Diversification and Rebalancing

by | Investing & Personal Finance

Soon many investors will be getting their 2016 mid-year 401(k), 403(b) or IRA performance reports. As markets are wont to do, last year’s poor performers—gold, high-yield bonds, global bonds—reversed course and are this year’s winners, reaffirming that the one free lunch available to investors is diversification.

Reviewing your accounts do’s and don’ts

Diversification is the proverbial don’t put all your eggs in one basket. So within an asset class like bonds, a diversified investor owns treasury bonds, corporate bonds, high-yield bonds, and international bonds, benefiting from the fluctuations from year to year in returns.

How Much International Stocks and Bonds Should You Own?

Maximum Retirement Account Limits for 2017

2016 bond market returns so far

Benefiting from a reversal in the strength of the U.S. dollar, the Barclays Global Aggregate Bond Index—which consists of currencies and bonds from all over the world—is up 8%, as the conventional wisdom that rising interest rates in the U.S. would push the dollar higher has yet to materialize.

U.S. bonds have also done well this year. The Barclays Aggregate Bond Index, which consists of treasuries, government-related bonds, and corporate bonds, is already up 4%. High-yield bonds (riskier corporate bonds) had it tough last year—but the Standard & Poor High Yield Corporate Index reversed course, and is up 9% this year.

Strangely enough, Treasury Inflation Protected Securities (TIPS), are up. The Barclays Capital U.S. Treasury Inflation Protected Securities Index is up 4%, though what it is designed to protect against inflation remains tame.

The stock market and gold market returns

Stocks have been up and down. After a rocky start to the year, the S&P 500 is almost 5%. However, the MSCI Index, which represents large and mid-cap stocks across 21 developed countries excluding the US and Canada, is down 1%.

The MSCI Emerging Market Index is down 3%. Its performance has been hurt by the sluggish Chinese stock market, which is down 17%. Many worry that a debt-bubble may be bursting in China.

Gold had fallen from $1,800 an ounce down to $1,104, but it has rallied to $1,215. It would need to go up another 48% to get back to its 2011 high. Time will tell whether this year’s rally is the start of a new bull market or a bear-market bounce.

Buying Gold: Trick or Treat

Rebalancing Your Portfolio

Because the stock market is significantly overvalued at this time, now is a good time to consider rebalancing your portfolio. By rebalancing instead of selling what has gone down or buying what has gone up, investors remain diversified but go back to their original allocation.

So while diversification is about the eggs, asset allocation is about the basket. What percentage of your basket is going to be in stocks and bonds?

For example, if six years ago you were comfortable with an asset allocation of 60% in stocks and 40% bonds, now, after the doubling of the stock market, that portfolio might be 75% stocks and 25% bonds. Rebalancing simply puts your asset allocation and its risk level back to the original 60/40.

Retirement accounts are ideal for re-balancing, because they enable you to buy and sell within the account with no tax consequence, and usually no fee or commission.

If You Have a Retirement Plan, You Will Need to Know About the Best Interest Contract Exemption

Investors approaching retirement who fail to rebalance might unwittingly end up closer to retirement with a riskier portfolio. That is why, when such investors rebalance, they might want to update their targeted allocations. For example, an investor with a portfolio that was 60/40 five years ago and now 75/25 could rebalance to 35% stocks and 65% bonds.

We will have to wait and see what the rest of the year brings. As the adage goes, past performance is not indicative of future results. However, with a presidential election like none we have had before, combined with a Federal Reserve bent on raising the Fed Funds Rate, things should get interesting.

*Diversification, rebalancing, and asset allocation strategies do not assure a profit or protect against loss.

2016 Midyear Results as of 06-25-2016

Comparison of Returns of Different Asset Classes (Investors cannot directly invest in an index)
Asset ClassTotal Return2015 Return
Barclays Global Aggregate Bond Index8.41%-3.5%
S&P High Yield Corporate Index 8.66%-2.52%
The Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) 5.6%-1.44%
Barclays Aggregate Bond Index4.74%0.55%
The MSCI Emerging Market Index + China-6.78%-3.78
MSCI EAFE Index-8.68%.39%
S&P 500 Index.74%1.2%

These are the opinions of Financial Advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.

Financial advisor in Boston, MA

Boston Skyline

About

Tim has been a professional financial advisor for 26 years. He specializes in building custom portfolios for people that are saving their money for retirement or are already retired.

Archives

Pin It on Pinterest

Share This

If you enjoyed this article please share it with your friends, family, and co-workers.

Shares
%d bloggers like this: