There has been a lot written about investing and markets over the years.
Probably the finest writing on asset allocation and portfolio rebalancing that I have ever read was written by Benjamin Graham one of the fathers of “Value Investing” and the mentor of Warren Buffett. The following paragraph may provide answers to investment success in very few words:
We recommended that the investor divide his holdings between high-grade bonds and leading common stocks; that the proportion held in bonds be never less than 25% or more than 75%, with the converse being necessarily true for the common-stock component; that his simplest choice would be to maintain a 50-50 proportion between the two, with adjustments to restore the equality when market developments had disturbed it by as much as , say 5%. As an alternative policy he might choose to reduce his common stock component to 25% ”if he felt the market was dangerously high,” and conversely to advance it toward the maximum of 75% ”if he felt that a decline in stock prices was making them increasingly attractive.”
Benjamin Graham, The Intelligent Investor Fourth Revised Edition 1973
These words address many of the challenges of markets especially in the modern world. The paragraph can be broken down into the following points (my comments follow each point):
An investment portfolio should ideally not have less than 25% in stocks or more than 75% in stocks.
Another way to consider this is that all portfolios should perhaps have a minimum of 25% in stocks to add some growth and protect against inflation. This modest weighting should not offer meaningful volatility in a portfolio. Despite current low interest rates, balanced and growth portfolios should strongly consider including fixed income as a diversifier to potentially lessen volatility. As we have reviewed GICs might be a good option in the current environment.
The “simplest” asset allocation would be 50% stocks and 50% bonds.
The new 50/50 is widely agreed upon to be 65% stocks and 35% bonds or even 70/30 for a Balanced Portfolio. This change is due to the extremely low level of interest rates relative to the income needs of investors and pension funds. If/as interest rates move higher in the coming years the preferred ideal allocation might potentially be revised back towards 50/50. The important point is to have a preferred asset allocation that can serve as a foundation in all market environments.
The Portfolio should be rebalanced if the preferred asset allocation changes too much.
This Rebalance is extremely important to investment success and forces the selling of assets when they are high and the buying of assets when they are low.
One should consider buying low and selling high by having a higher stock allocation when stocks are considered inexpensive and a lower stock allocation when stocks are considered expensive.
This considers the value of having a contrarian leaning to asset allocation; selling when there is optimism and greed in the markets and buying when there is pessimism and fear. Difficult to do but the strategy should prove valuable in times of market extremes like in 1999 (greed) and 2008 (fear).
Success with wealth creation and retention would seem to strongly result from discipline and process rather than on one’s ability to predict the future. One should not be “all in” or “all out” of the equity market, but have a determined asset allocation of stocks and fixed income that drives the whole investment process.
When equity markets are too strong, discipline should force the trimming of equity positions not because the market might possibly decline but because the risk of the portfolio has increased due to the change in the asset allocation. When equity markets are weak, one might consider adding to equity positions not because the markets might potentially appreciate but because the risk of the portfolio has decreased due to the change in the asset allocation.
This publication is solely the work of Jon Batchelor for the private information of his clients. Although the author is a Manulife Securities Advisor, he is not a financial analyst at Manulife Securities Incorporated and Manulife Securities Insurance Inc. This is not an official publication of Manulife Securities. The views, opinions and recommendations are those of the author alone and they may not necessarily be those of Manulife Securities. This publication is not an offer to sell or a solicitation of an offer to buy any securities. This publication is not meant to provide legal, accounting or account advice. As each situation is different, you should seek advice based on your specific circumstances. Please call to arrange for an appointment. The information contained herein was obtained from sources believed to be reliable; however, no representation or warranty, express or implied, is made by the writer, Manulife Securities or any other person as to its accuracy, completeness or correctness.