Why A Mixed Portfolio Outperforms Shares Long-Term?

Investment peace of mind is invaluable – as is a true mix of assets over the long-term Ümit Bulut

Diversify! It’s a mantra financial advisers often urge on us. Invest some money in UK shares but make sure you invest in Europe and the US too. Sprinkle a little in Japan and emerging markets perhaps. Not too much, mind.

Investing in shares this way sounds sensible. But a more mixed portfolio invested in other assets like bonds as well can – and does – return more than being solely invested in stocks. It’s a smarter, more counterintuitive position and not so well-known either.

How so? Different types of assets rarely move in the same direction or at the same speed (let alone at the same time). When stock suffer, their ups and downs are often wider or dramatic than for bonds or cash.

The volatility, simply, is more extreme. As well as fairly perilous, often, for financial planning, if the long view is not taken.

Profit from uncertain financial weather

Ideally what most of us need is the reward potential from shares but with that risk managed. So whatever the state of the market we don’t just weather gustier squalls but we have a chance to be better insulated from them. Long-term, this approach makes you better off.

“Diversification is the only free lunch in finance,” says AdviceBridge’s Sheetal Dhanuka. “When equities go down you buy more equities and when bonds go down you buy more bonds.”

Market ice and rain presents fine buying opportunities for genuine diversification Vidar Nordli-Mathisen

He goes on: “In other words, it’s not about picking what is going to be the best return over 20 years. Having your portfolio spread broadly and having someone manage it for you in an efficient way adds real value.”

In other words: such a strategy can force you to buy when the price goes down – and forces you to sell when the price goes up. Overall asset composition – forgive the City-speak, briefly – is an important tenet of long-term investing.

  • If this sounds a bit institutional, think in terms of a balanced blend of shares, bonds and perhaps other assets you can live with long-term
  • In other words, avoiding putting your eggs in the same basket improves your chances of preserving and building your assets 

Furthermore, you’re not under pressure to anticipate market volatility or market timing. Which is quite impossible, even for highly-seasoned investors.

A number of different eggs but how should they be shared around long-term? Jakub Kapusnak

Deploy the power of re-balancing

Regular re-balancing of how and where we’re invested helps us manage risk. As regular servicing keeps a car on the road, your investments also benefit from periodic tune-ups.

For example, let’s say you’re invested 50/50 between shares and bonds. During the following year your equity investment rises 30% in value. Which means your overall shares exposure has now become top-heavy at 65% not 50%. 

You are now in a position to put some of the new gains back into lower-risk bonds, ‘locking in’ the profits so your original target allocation is restored.

  • You are selling investments that have performed strongly and buying investments have shown weaker performance
  • This is selling high and buying low (or lower). It is not ‘timing the market’. It is sensibly accepting that no asset can maintain a sprint indefinitely

No sprint lasts forever, however, impressive the speed or the roar of the stadium crowd Braden Collum

Some people prefer to re-balance annually. Other people prefer to do it less – or more. It depends on your capacity for loss, your investment objectives, and your comfort levels. 

But – good news – this decision process can be automated, depending on your fund choice. This takes care of the painful decision-making.

How does this strategy look and feel in practice?

In academic-speak combining stocks, bonds and other assets are often compared to Modern Portfolio Theory (espoused by American Nobel Laureate economist, Harry Markowitz in 1952). 

Typically a mixed portfolio might be made up of:

  • 25% large-cap UK companies
  • 10% small-to-medium UK companies
  • 30% overseas large-cap companies
  • 30% government and corporate bonds
  • 5% cash

There’s another reason to adopt this tack. Simply, our own emotional comfort. Most of us can’t live with being invested in just one asset class. 

That risk – a slow drift into danger over time – can gnaw at our need for long-term reassurance. If the value of our investment dives when we need it most then it could be a permanent loss. The opportunity to remain invested while markets recover is then gone forever.

Stock markets are capricious and reliable insight is often uneven – though opportunities abound AbsolutVision

Do bear in mind:

  • Our investing world has not just become bigger – more opportunities in different ‘vehicles’ – but more complex. The money markets are not just shaped or driven by economics but, increasingly, politics and external events. Think of the (January 2020) coronavirus worries in China and, further back, the UK’s 23 June 2016 Brexit vote
  • All the more reason, then, to keep an eye on your risk exposure. Remember that there’s no such thing as the perfect investment approach. Markets are always changing. We can’t control them but we can control our response to them

Behavioural finance has much to say about our personal risk levels and how we feel about them. However, a measure of on-going practicality and education here can save a lot of reading. Consider this article on Why you need to know about your capacity for Loss

Conclusion

It’s important to find the right balance between your own investment expectations and how much risk you can actually tolerate – the latter being rather more important than the former.

When economic or political volatility is higher than usual, re-balancing is an excellent discipline. As is holding a mix of shares and other assets.

Election voting may dramatically alter your investment outlook across many jurisdictions Arnaud Jaegers