At WT Wealth Management (WTWM), we construct portfolios that reflect the risk tolerance of our clients. Putting the right mix of assets together, though, is complicated. Ideally, your portfolio will reflect two important considerations:
- How much time you have to achieve your investment goals, and
- What kind of tolerance you have for taking on risk.
A suitable portfolio therefore balances your personal financial goals with your risk comfort level. Just because you can afford to lose principal does not mean you can personally stomach the losses. An ideally diversified portfolio is, therefore, also a personalized one. Studies have shown that how you decide to allocate your assets is more important than which individual securities you choose to own within any specific asset class1
Investopedia defines diversification as "a risk management technique that mixes a wide variety of investments within a portfolio." By assembling a broad group of assets, an investor can reduce the chance of significant portfolio losses while simultaneously achieving higher expected returns. This is what some call the "only free lunch" in investing, resulting in less bad news and more good news, simply because you hold different investments that respond independently to various market conditions. It is also what makes diversification so special. If one asset is performing poorly, it is likely that another, less-correlated asset may be doing well.
Since stock markets hit their highs in late February, we have witnessed tremendous volatility across almost all asset classes, resulting in some portfolios being less diversified and, in many cases, even too conservative for an investor's original objectives.
One of the hardest psychological investment challenges is selling your investment winners and buying more of your losers. However, by rebalancing in this way, we bring your portfolio weightings back to their original asset allocation. During the last eight weeks, you probably noticed that WTWM more actively made changes to your portfolio holdings. These included a rare intra-month trade, triggered by equally extreme intra-month volatility. Every trade we executed was to ensure your portfolio was properly balanced.
On March 13th, we did a special rebalance and sold "safe assets" like bonds and gold. This was a hard decision to make, with so much market uncertainty at that very moment. But both bonds and gold had been very strong performers, and stocks were down significantly. This rebalance did not work out immediately (you only know the market bottom in retrospect). But as of today, with stocks up strongly, rebalancing back to the target weight in stocks has worked out quite favorably.
Bought Corporate Bonds:
On April 13th, we sold a portion of our U.S. Treasuries (loans to the US Government that did very well as safe haven assets during the market downturn) and, as a substitute, bought investment grade corporate bonds (loans to US companies). We believe that the extra return earned in lending to US companies (versus lending to the US government) is attractive enough to assume the extra risk. That decision has also been a significant net positive since the trade.
Swapped High Yield Holdings:
On April 13th, we also swapped our high yield fund to a shorter-term high yield fund. Given the significant fear in the market, the rates on short-term high yield bonds exceeded those of longer-term bonds. To date, this has been a minor positive contributor as well.
Increased High Yield Holdings:
About a month later, we further increased our high yield risk exposure from an underweight position to neutral, where it sits today. Our analysis showed that the risk/return trade-off had significantly improved as a result of investor moves into safe-haven assets. To date, this trade is showing a slight negative impact to client portfolios compared to a portfolio that retained the underweight high yield position.
Please do not confuse these actions as trying to "time the market" for outsized gains. Quite the opposite; we believe it is "time in the market" that earns investors the highest returns long-term.
With portfolios rebalanced, our clients are appropriately positioned to achieve returns consistent with their personal objectives. And of course, WTWM's Investment Committee will continue to monitor and make adjustments as needed.
1 A classic and frequently cited empirical study is Brinson, Hood, and Beebower (1986). These authors interpreted the importance of asset allocation as the fraction of the variation in returns over time attributable to asset allocation, based on regression analysis.