The financial news has been filled lately with a series of record highs for the Dow Jones Industrial Average and historic highs for other indices. These have been accomplished in spite of an economy that does not feel terribly strong and continued uncertainty in Washington DC over the budget issues. Times like these continue to remind us how important it is to make sure your investment strategy is consistent with your goals, return requirements, and risk tolerance.
We have always stressed the importance of making sure your asset allocation is consistent with your goals. Diversification has been a key component of this approach, not as a way to boost returns, but to reduce your risk. Over the long term, we still believe diversification works across a wide variety of asset classes that have various degrees of correlation with each other. When we are in financial crises like 2008/2009, many asset classes moved together, but bonds (and especially T-Bills) rose sharply.
Having elements of your portfolio positioned to do well in various economic scenarios is an important part of a well diversified approach. If the economy continues to expand, stocks and real estate should do well. If we go into a recession and see a downturn in stocks, bonds typically have performed well. Many people are concerned about inflation becoming an issue, so having some of your portfolio in asset classes that would do well in that scenario (TIPS, commodities, real estate, etc.) might make sense. If we see deflation, stocks and bonds (especially Treasury bonds) would hold up better.
Over the past 10 years, we have seen a wide variety of returns on different asset classes. This chart shows this and also highlights the fact that an asset allocation blend of the various asset classes helps to smooth out the volatility. If you look at the 5, 10, and 20 year rolling time periods in this chart you see that a 50/50 mix of stocks/bonds would not have lost money in any of these rolling time periods. Again, the benefits of diversification may not always be clear, but they are clear over the long term.
Our goal has always been to help you stay focused on your long term goals and not react to short term events. We do not believe you can successfully time the market over the short term. It might be tempting to increase your equity holdings when you see such large gains everyday. On the flipside you might try to time your exit from equities at the top. Instead, you should simply rebalance any positions that have gotten out of balance with your asset allocation targets. This can help you balance your portfolio without the pressure of deciding how or when to buy/sell. It is easy for your portfolio to get out of balance when we have dramatically different returns on different asset classes, like we saw in 2012.
If you would like us to help you take a closer look at your portfolio in light of your goals and objectives, please let us know.