As the world grapples with projections of what it will take for the economy to recover from COVID-19 and the stunning collapse of global oil prices, there’s still the matter of risk that the next headline-driven sell-off could push markets even lower than levels seen thus far. So, what can investors do to shield against further volatility but not lose sight of an eventual market rebound?
Rebalance and repeat
Consider that a diversified stock-bond portfolio comprised of 60 per cent equities and 40 per cent fixed income has shown to perform slightly better in market sell-offs. While the standard 60/40 mix may have some difficulty keeping pace when markets pick up steam, a fixed-income allocation can help. As markets depreciate or undergo a correction, a balanced portfolio will inherently become overweight in fixed income, and by selling some of those fixed-income assets and buying depressed equity to rebalance, the portfolio will take advantage of those opportunities.
“The data we’ve collected over the past four decades illustrates that rebalancing your portfolio as often as quarterly or at the very least, annually, is a solid strategy to cushion the impact of volatile economic conditions,” says Philip Petursson, Chief Investment Strategist, Manulife Investment Management. “This way, investors can reduce their equity risk, add some protection against the downside, and at the same time, take advantage of lower equity costs that are well-positioned for growth. When you compare a balanced portfolio to one that consists of 100 per cent equity, you see less downside risk, but also see similar upside performance over extended periods of time.”
Investment growth of $10,000 — equity portfolio vs. balanced portfolio (since 1976)
Adaptation is key
Clearly, emotions can run high during a severe crisis or event and can influence the way we would normally react. With highly charged emotions during a sudden market sell-off, some investors feel compelled to sell their assets and flee the markets altogether, and therefore, will stand to gain nothing. Others may decide to play it safe, transfer everything to cash, and wait on the sidelines for the economy to fully recover. With this approach, investors may simply be exchanging the anxiety of being in the markets with the anxiety of being out of the markets and may miss the initial recovery while they wait for added confirmation. See the graph below to understand how this affects a portfolio over the long term.
A willingness to adapt to changing market conditions is key to helping investors offset any tendency to think of themselves as victims during unpredictable times. Manulife Investment Management’s portfolio managers recommend investors seek the expertise of their advisor to learn about the benefits of rebalancing their portfolio, as well as the advantages of asset allocation and dollar-cost averaging that can help them withstand the effects of an economic storm.
Portfolio comparison (since 2007)
As seen here, a balanced portfolio offers better protection during a down market, wherein the quarterly rebalance allows for the purchase of equities at a discounted rate.
“Statistics show that investors can seize the advantages of a downward market sell-off by shifting their asset allocation to the lower-valued asset class, which, in effect, is dollar-cost averaging without having to commit new capital,” adds Petursson. “If you stick with the fundamentals and set your portfolio back to its intended target weights, it will reap the benefit of underpriced equity when markets begin to rebound.”
The events of recent weeks have upheld the fact that no one can readily predict the time when markets will crater and eventually hit bottom, or even where that bottom might be. But when markets do begin to tumble, staying invested and rebalancing quarterly will far outweigh the benefits of jumping ship.
Support materials on market volatility, the value of advice, and the importance of staying invested can be found in Viewpoints