Markets & Economy
Asset allocation and disciplined rebalancing
April 15, 2013
Amy Chain: Sarah, maybe you could tell us a little bit about the roles that bonds or bond funds should be playing in an investor's portfolio.
Sarah Houston: I think a key to a sound investment strategy really is whether an individual creates that suitable asset allocation. So what is that mix of stocks, bonds, and cash that really works for their specific situations? So looking at their goals, looking at their risk tolerance, and looking at also what's their time horizon for investing and needing those funds as well.
And each asset class really does have a particular role to play in that portfolio. So stocks, they're predominately there for their growth potential beyond inflation. With that potential growth also comes some potential volatility. Bonds, as our viewers tend to know, they really are there to help moderate that volatility and help to mitigate some of the stock market risk and also to produce some income. And then cash is really there for the short-term spending needs or for preservation of capital. And then that diversification, in terms of the mix that you have, it's a really powerful strategy when it comes to managing the overall risk in that portfolio.
And if you think about it, it makes sense, and you kind of alluded to it, that the markets don't perform in tandem in terms of stock market, bond market. And by holding a mix across the different asset classes, what you really are enabling yourself to do is to participate in the strong performing ones but also mitigate the impact of the weaker ones to your overall portfolio.
Amy Chain: And we talk about having an allocation and sticking with it, so maybe you can tell us a little bit about when it might be appropriate to reconsider your allocation and when maybe not.
Sarah Houston: Yes, absolutely. I think a good rule of thumb to think about, when to come back and look at that strategic asset allocation that you've set for yourself, is to think about it in terms of significant life events. So when something may have really changed and you want to take another look at risk return characteristics, have things changed for you? So that could be a birth of a child; could be marriage; could be even a significant upcoming cash expenditure, maybe child's college tuition, buying a home, those type of things.
I think another time, which really kind of gets to the life stage as well, is someone who's approaching a planned retirement. And when someone is approaching a planned retirement and knows that there won't be a salary coming in, there are some investors that view that as an opportunity to really lower the volatility of their overall portfolio and—to do that—maybe increase bond allocation.
There's another time when we actually think it makes a lot of sense to readjust what your allocation is, and that's when it comes to—because markets perform differently, if over time say a bond allocation has risen or fallen and has drifted away from what that strategic asset allocation that you set was initially, then it makes sense to take a look and say, "do we need to rebalance?"—is essentially what we're talking about, to get back to the original risk and return characteristic that you were looking for.
Amy Chain: So it's checking your current allocation against your original game plan and making sure that the two are still in line.
Sarah Houston: Absolutely. And I think we've got a chart that does a nice job of really illustrating what some of the potential benefits of that can be. If you look at this chart what you actually see is, on the left-hand side you've got an investor who invested $100,000 at the beginning of 2008, which we know was a significant year in terms of there was a significant market sell-off for stocks, 60-40% split between stocks and bonds, so a balanced investor. What the middle chart actually shows is that after five years, at the end of 2012, if that investor had not rebalanced at all, what the mix of their portfolio would look like.
And it's actually not distressing, right? It's a fairly nice return, but contrast that with what you see on the far right-hand side. And what the right hand shows is really if that investor had been disciplined and actually rebalanced after that market sell-off, really as Ken mentioned before, enabling them to even participate more in the undervalued class at that point in time, they were in a better position at the end of 2012.
All investments are subject to risk, including the possible loss of the money you invest.For more information about Vanguard funds, visit Funds, Stocks, & ETFs or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
Bonds and bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.
© 2013 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.
The importance of rebalancing your portfolio
Bonds can play an important role in a portfolio but market swings often throw an investor's asset allocation out of sync. Sarah Houston, head of Vanguard Flagship Services®, explains why's important to rebalance your portfolio to keep your target allocation in check.
Other excerpts from this webcast:
- Ken Volpert on the current bond landscape
- Understanding bond prices and dividends
- The role of an international bond fund in your portfolio
- Spending from your portfolio: Total return versus income
- All investments are subject to risk, including the possible loss of the money you invest.
- For more information about Vanguard funds, visit Funds, Stocks, & ETFs or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
- Bonds and bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
- This webcast is for educational purposes only. We recommend that you consult a financial or tax advisor about your individual situation.