The good news.
Looking for good investment news lately has felt like searching for a needle in a haystack. The print headlines shout, the evening news trumpets and the latest brokerage statement confirms that, yes, stock markets have been brutal. It’s easy to be overwhelmed.
There is good news. Two fundamental investment tools – asset allocation and diversification – still work. According to Barclays’ ishares.ca index returns tool, in 2008, Canadian stocks returned a brutal -33%. But Canadian bonds returned a comfy 6.4%. So an investor’s portfolio, balanced with a 60% stocks and 40% bonds asset mix, delivered a -17% return. For sure, 2008 performance numbers were dramatic. Normally, returns both up and down are more muted. Over the last 3 years, for example, the zig of bonds almost entirely offset the zag of stocks producing nearly a zero % return for the same balanced portfolio.
Allocating assets to stocks and bonds helps to smooth overall portfolio performance because bonds buffer stock market volatility. In 2008, the balanced investor with bonds in their portfolio benefited and survives to invest another day. (Remember though it works both ways. In a bull market, a balanced portfolio will be more average too. Average is not good enough for some).
Why does a balanced portfolio work?
Stocks (over time) tend to deliver higher returns than bonds because stocks are riskier and the investor must be compensated more for accepting this higher risk. Bonds, on the other hand, chug along paying (low) interest payments. How boring. Until something goes wrong in the stock market. Then investors sell their stocks – often indiscriminately, at any price, driving the price of stocks down – and rush to the relative safety of bonds, driving the price of bonds up.
We forget this last part. It’s the capital gain from bonds during a stock market crisis that change the role bonds play in a portfolio from slow and sure to insurance payday. With interest rates at historic lows, how else did bonds produce a 6.4% return in 2008? A third came from bond price gains in addition to the normal bond interest payments.
What markets do from here is not such issue for the investor with a balanced portfolio because it will benefit regardless of market direction.
Is now the time to buy or sell? Timing investment transactions can never be certain. And balancing a portfolio is an ongoing process not a one-time event. Some investors could rebalance to their desired stock / bond asset mix by buying or selling stocks or bonds – exchanging one for the other. Some might rebalance with their RRSP contribution. Still others might rebalance by averaging their purchases (or sales) over time. However long it takes to get back into balance is not the point. The point is a balanced portfolio works.
Originally published in the Business Thompson Okanagan news, February 2009.
Doug Cronk CFA, is Manager Investments for a Canadian Pension Fund.