Time to check risk exposure?
15 March 2018 | Topical insights
For equity investors, 2017 was an epic year. And it came on the heels of an historic bull market in global equities stretching back to the spring of 2009.
So far 2018 has also been epic, but in a different way. Markets in Europe, North America and the Asia-Pacific region fell sharply in early February, rebounded, fell again, rebounded and remain somewhat unsettled.
Given this backdrop, now might be a good time for investors to check in on their portfolio's asset allocation – that is, how their money is divided among shares, bonds and short-term reserves (cash). Thanks to the equity markets' long rally, there's a chance an investor's allocation to shares may be greater than he or she originally intended.
Know your comfort level
Owning a higher percentage of shares might be a good thing – especially if the market resumes its ascent. But if the market heads in the other direction, it puts a portfolio at risk. Because no one knows which way the market will go, Vanguard suggests choosing a mix of equity and bond investments that investors feel comfortable with over the long run and rebalancing back to that mix when market movements veer the mix off course.
Here's an example of how the markets can change a portfolio's risk level: Based on market performance alone, an investor who owned a 60%/40% mix of US shares and bonds in early 2003 would have drifted to a 75%/25% mix four years later, just as the global market was heading for a hard fall. History may or may not repeat itself. But investors can keep the risk level constant by rebalancing their portfolio.
Guidelines for rebalancing
Vanguard recommends rebalancing once a year or after an allocation shifts by five percentage points or more. For those needing a quick refresher, here's how to get started:
- Determine the target asset allocation, taking into consideration financial objectives, time frame, and comfort with risk exposure.
- Evaluate the current allocation. If the current mix differs from the target mix by 5 percentage points or more, an investor may want to rebalance.
- Avoid unnecessary taxes. Rebalancing by buying and selling investments in taxable accounts could trigger tax consequences. So an investor may want to take a cautious approach by directing future investments to under-allocated asset types, rather than shifting existing money around.
Put it on autopilot
It takes discipline to keep a portfolio balanced. After all, it often means moving away from equities after they've provided high returns. Investors who are having a hard time putting a rebalancing plan into practice can consider these options:
Invest in a balanced or multi-asset fund. Investors can choose from different types of balanced funds depending on needs. Vanguard LifeStrategy® Funds are available in a variety of risk profiles and are regularly rebalanced to maintain a fixed strategic asset allocation. Vanguard Target Retirement Funds are designed to help invest for long-range goals by shifting money from equities to bonds as their target date approaches.
Professional financial advisers should make rebalancing an ongoing priority. Advisers should compare a portfolio's current asset mix with the target every few months to help keep on track to meet their clients' long-term goals.
Buying low and selling high
Whenever equities have a great year, it can feel wrong to consider trading shares for bonds. Instead, investors tend to get carried away, often investing more money in equities as prices climb.
But the oft-repeated advice is to "buy low and sell high." That's why rebalancing works – it encourages investors to cut back a bit on a rising investment and buy a bit more of the lagging category.
Investment risk information:
Past performance is not a reliable indicator of future results.
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
The Vanguard Target Retirement Funds and Vanguard LifeStrategy® Funds may invest in Exchange Traded Fund (ETF) shares.
The fund(s) may invest in financial derivative instruments that could increase or reduce exposure to underlying assets and result in greater fluctuations of the fund's Net Asset Value. Some derivatives give rise to increased potential for loss where the fund's counterparty defaults in meeting its payment obligations.
Other important information:
This document is directed at professional investors only and should not be distributed to, or relied upon by, retail investors. It is designed for use by, and is directed only at, persons resident in the UK.
This article was produced by The Vanguard Group, Inc. It is not a recommendation or solicitation to buy or sell investments.
The opinions expressed in this article are those of the individual author and may not be representative of Vanguard Asset Management, Ltd.
The Authorised Corporate Director for Vanguard LifeStrategy® Funds ICVC is Vanguard Investments UK, Limited. Vanguard Asset Management, Limited is a distributor of Vanguard LifeStrategy Funds ICVC.
For further information on the fund's investment policy, please refer to the Key Investor Information Document ("KIID"). The KIID and the Prospectus for this fund is available from Vanguard via our website https://global.vanguard.com/.
Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.