Balancing your portfolio in a bonkers market

September 26, 2011

Balance is a rare bird these days. Jobs, housing, stocks, European debt: All seem to be in a spasmodic tailspin.

There is some consolation that a balanced portfolio can help smooth out the jagged curves of a bipolar market economy. But balance is rarely what we think it is, and it needs constant monitoring.

When most investment advisers tout a balanced portfolio, it typically means one thing: About 60 percent would be invested in a U.S. all-stock fund and the remainder in bonds.

A good proxy for the stock component would be the index exchange-traded fund SPDR S&P 500 fund. U.S. bonds could be ably represented by the SPDR Barclays Aggregate Bond ETF.  Both funds are low cost, diversified ways of owning the lion’s share of each market. Here’s how the returns break out, according to Craig Israelsen, professor of finance at Brigham Young University, who analyzed the underlying indexes:

A balanced portfolio is roughly half as risky as an all-stock mix. If you looked at August’s returns, you would have only lost 2.75 percent in the 60/40 portfolio, compared to a 5.5 percent loss in the all-stock portfolio or a 1.37 percent gain in the much safer all-bond portfolio. No surprises there because bonds are safe havens when investors flee stocks as they did during last month’s volatility — and may continue to do so in a broad-based pullback.

Let’s look back even deeper into the past decade, which included two recessions, 9/11, the 2008 meltdown and the dot-com blow-out of 2001. Bonds are again the best performers as a buffer against stocks — returning 5.5 percent vs. 2.59 percent for 100 percent stocks. Between those two extremes was the balanced portfolio, with a 4.1 percent return through August 31.

In an even more volatile period — going back only five years to include the 2008 meltdown, recession and recovery — bonds again came out on top with a 6.26 percent return, compared to 0.74 percent return for all stocks and 3.3 percent for the balanced mix.

It’s hard to argue against being all in stocks or bonds at the right moments. In good times, stocks are the place to be as you’re rewarded with dividends and capital appreciation based on corporate earnings expectations. When the skies darken, though, bonds are decent hideouts due to their steady payments and appreciation when interest rates decline. Yet how do you time the market? That’s what makes the balanced approach a solid middle ground that lowers both stock and bond-market risk simultaneously.

Long-term, the middle route makes a huge difference. From 1926 through 2010, according to a recent T. Rowe Price study, a balanced portfolio delivered returns above 10 percent almost as frequently as an all-stock portfolio — with 40 percent less volatility.

That means in a dreadful year for stocks, the balanced portfolio would only lose 28 percent, compared to 43 percent for the 100 percent stocks mix.

The balanced approach is a compelling argument for mutual funds that automatically do the 60/40 allocation and for target-date or lifestyle choices within 401(k)-type plans that do the same thing only with specific years targeted for retirement withdrawals. Every major mutual-fund firm offers them as does Folio Investing.

You could also build a balanced portfolio on your own by buying the two SPDR funds I mentioned above. Buy them through a deep-discount broker or find their equivalents commission-free through Fidelity Investments, Charles Schwab or the Vanguard Group.

Want to take the balanced approach one-step further? Consider an ultra-balanced approach with at least 12 separate funds representing seven asset classes, such as the ones found in the 7-12 portfolio. Over the past five years, the passive version of 7-12 has returned 4.8 percent, compared with 3.87 percent for the Vanguard Balanced Index and 0.71 for the Vanguard 500 Index fund, according to Israelsen, who designed the portfolio.

Israelsen has expanded the definition of balanced portfolios by including inflation-protected bonds, cash, natural resources/commodities, global real estate, emerging markets and all sizes of companies. This model reduces risk through diversification and includes tangible assets such as commodities and real estate.

What’s important in a balanced approach for moderate to conservative investors is that more global asset classes get you away from the all-U.S. stocks and bonds orthodoxy. This diversity not only gives you room to breath, you’ll never fly too close to the sun.

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While Mr. Israelsen definitely advances the discussion by adding additional funds to further diversify the conventional 60/40 portfolio, it is simple to improve on this even further. In my book “Jackass Investing: Don’t do it. Profit from it.,” I introduce the concept of “Return Drivers” (they replace “asset classes,” which I classify as an archaic artifact of our investment past). This allows for “true” portfolio diversification. In the “Action Section” for the book I then show a specific “Free Lunch” portfolio that produces both greater returns and less risk than either the 60/40 or Mr. Israelsen’s portfolio, using just ETFs and mutual funds. You can learn more at or

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