Numerous studies and Nobel Prize-winning research over the last fifty years shows that over the long term that 95 percent of a portfolios performance will be determined by its asset allocation. Only 5 percent is determined by the return of the individual investments. In other words, asset allocation will have more to do with the success or failure of your portfolio than finding the best-performing investments. How can that be? That makes absolutely no sense. After all, what matters more than having the best investments? Consider the following example. It’s 2008, and you have $100,000 to invest. You decide to invest $70,000 in the Fidelity Contrafund (4 star fund) and $30,000 in the Vanguard Total Bond Market Index Fund (3 star fund). Your asset allocation is 70 percent stocks and 30 percent bonds. For the year, the Contrafund lost 37 percent, and the Vanguard Bond Market Index Fund gained five percent. As a result, you end up with $75,600 – a loss of almost 25%. If instead you invested $70,000 in the Vanguard Total Bond Market Index Fund, and $30,000 in the Fidelity Contrafund your portfolio with an asset allocation of 70 percent bonds and 30 percent stocks would be worth $93,000, – a loss of only 7 percent. In both instances the funds in each portfolio were the same however the ending values were not. The $17,400 difference between the two portfolios was due to the difference in the asset allocation.
When it comes to investing, the goal is to increase your savings, but not at the risk of jeopardizing your lifestyle or your financial security. During my 15 years as a registered investment advisor I have always been amazed how many individuals in their fifties and sixties invest so much of their retirement savings in stocks. The statistics also back this up. According to the Employee Benefit Research Institute, over forty-percent of investors between the ages of 56 and 65 had more than 70 percent of their retirement savings in stocks into 2008. At Capital Wealth Management we believe a more prudent asset allocation should be closer to the opposite end of the risk spectrum. As a result, the majority of our client’s assets who are close to, or in retirement, are invested in a diversified multi-asset class portfolio comprised of 30 percent stocks and 70 percent bonds.
A portfolio with an asset allocation heavily weighted in stocks can expose an investor to the risk of a significant financial loss during down markets The accompany chart shows how a portfolio with an asset allocation of 70 percent stocks and 30 percent bonds, and a portfolio of 30 percent stocks and 70 percent bonds performed during each of the stock markets seven worst bear markets. The top line shows that during the Great Depression (from Sept. 1929 to July of 1932), the U.S stock market lost 86 percent. During this time, the 70/30 portfolio lost a whopping 56%, while the 30/70 portfolio lost only 16 percent. The bottom line shows that the 30/70 portfolios average loss in ten bear markets were “significantly smaller” than the U.S. stock market and 70/30 portfolio.
|Sep 1929 – Jul 1932||-86%||-56%||-16%|
|Mar 1937 – Apr 1942||-60%||-40%||-13%|
|May 1946 – Jun 1949||-30%||-19%||-4%|
|Dec 1961 – Jun 1962||-28%||-17%||-2%|
|Feb 1966 – Oct 1966||-22%||-14%||-3%|
|Jan 1973 – Oct 1974||-48%||-31%||-8%|
|Nov 1980 – Aug 1982||-17%||-5%||+11%|
|Jul 1990 – Oct 1990||-19%||-12%||-2%|
|Apr 2000 – Mar 2003||-43%||-19%||+13%|
|Oct 2007 – Mar 2009||-57%||-37%||-11%|
Stocks: Dow Jones Index from 1929 to 1966; S&P 500 Index from
1973 – 2010. Bonds: Intermediate Term U.S. Treasury Bonds
Investors who use effective risk management strategies increase their odds of earning acceptable returns in both up and down markets. From 1926-2011 the 70/30 portfolio earned an average return of 8.4 percent. The 30/70 portfolio achieved an average return of 7.0 percent. Put another way, the 30/70 portfolio earned nearly 85 percent of the return of the 70/30 portfolio return while taking significantly less risk.