3 reasons to revisit your asset allocation strategy

WHEN THE MARKETS ARE GOING GANGBUSTERS, most people feel confident in their investing strategy. But when markets change and your portfolio starts to lose value, it can be easy to panic and wonder whether you’ll get back on track to meet your goals.

For many investors, that really hit home in early 2020, when stocks around the world dropped dramatically in response to uncertainty around the coronavirus pandemic. In the U.S., it marked the fastest and sharpest drop into bear market territory the Dow Jones Industrial Average had ever experienced.¹ But even minor bouts of volatility can unsettle investors.

It’s at times like these that your asset allocation strategy — or the percentage of your portfolio you’ve chosen to devote to different assets such as stocks, bonds and cash — can provide useful perspective. “Your long-term asset allocation strategy acts as a roadmap to help guide you through every kind of market,” says Marci McGregor, managing director and senior investment strategist in the Chief Investment Office for Merrill and Bank of America Private Bank. Helping to create a personalized asset allocation strategy that’s appropriate for your situation is one of the key benefits of working with a financial advisor.

The asset allocation that’s most appropriate for you is shaped mainly by four key factors that your advisor can help you identify: your financial goals, time horizon, comfort with risk and need for liquidity, or access to readily available cash. And it will likely change as you go through life. Younger investors might consider investing more heavily in riskier assets like equities, since they have time to make up for market downturns. Meanwhile, someone near retirement may want to have more cash and other less risky investments to help buffer against losses in equities. Your advisor can help you revisit your allocations and make adjustments along the way.

Below, McGregor points to three potential benefits of having a thorough asset allocation strategy, and why it’s never too early, or too late, to get started.

Helping you ‘stay the course’ in volatile markets

“When markets are volatile, it’s important to stay diversified and have a strategy for rebalancing,” notes McGregor. When you have an asset allocation strategy that aligns with your risk tolerance, time horizon and liquidity needs, you’ll be more likely to stay the course and keep focused on your goals. Why is that important? “History shows that pulling out of the markets when they are down can put you at risk of missing out on the subsequent rebounds that have always followed market declines.”

“The best days often come soon after the worst,” says McGregor. And missing those days can be costly. Going back to the 1930s, if an investor missed the 10 best performing days of each decade through June 1, 2022, their cumulative return was around 38% in total. If that same investor stayed in across all days in each of those decades, the cumulative return was approximately 19,020%.

Minimizing risk through diversification

Historically, bonds tend to move in the opposite direction of stocks, so having bonds in a portfolio has generally helped to minimize the effects of a down market. In the first half of 2022, however, both stock and bond markets saw significant volatility and negative performance. This was largely due to uncertainty with regard to inflation. In the coming year, we expect a more traditional relationship between stocks and bonds to return, says McGregor. An allocation that balances riskier investments, like growth or small-cap stocks, with lower-risk investments, like high-quality bonds, can potentially offer long-term growth, perhaps with less return, without putting your entire portfolio at risk. But diversification means more than spreading your investments across different asset classes; it also means choosing a broad selection of investments within the various asset classes, including stocks and bonds and, for qualified investors,² alternative investments, too.

Within the universe of bonds, for example, there are different sectors with varying degrees of risk, from U.S. Treasury bonds (low risk) to investment grade corporate bonds (a bit riskier) to high-yield bonds (the riskiest). You might also want to consider geographic diversification, by layering in some investments outside of the United States. Each of these types of bonds offers different fee and expense structures and potentially higher or lower returns, depending upon their level of risk.

Alternative investments, such as hedge funds, private equity funds and certain types of so-called real assets, can offer an added layer of diversification that qualified investors could consider. These types of investments are typically relatively illiquid — that is, they are not as easy to buy and sell as stocks and bonds. But their prices are often not correlated to those of more traditional investments and could offer potential for greater long-term returns, with potentially higher risk. How much you devote to alternative investments depends on your goals, liquidity needs and time horizon and could range from 5% to about 30% of your total portfolio, says McGregor. Your advisor can help determine whether alternatives are appropriate for your needs, risk tolerance and situation.

A roadmap for regular rebalancing

As time goes on, your portfolio will naturally “drift” from its initial target allocation, favoring assets that have been experiencing stronger returns.

The video below showing how an investor’s allocations might change over time is based on the S&P 500 Index - Total Return, Bloomberg Barclays Capital U.S. Aggregate Bond Index and ICE BofA U.S. Treasury Bill 3-Month Index (USD Unhedged).

Resetting your asset allocation to its original proportions — a process known as rebalancing — can help you make more measured decisions about when to buy and sell investments, as opposed to trying to time the market. You can consider rebalancing on a set schedule, say reviewing your allocation status every quarter or annually — known as periodic rebalancing — or whenever an asset strays outside of a given range, for example 5% from your target — known as tolerance band rebalancing. Your advisor can help you decide on a rebalancing strategy that is in your best interest. Over the long term, rebalancing may also be used as a tool to reduce volatility in your portfolio.

Arriving at an asset allocation you feel is appropriate for your situation takes some time and planning. But given what’s at stake, that’s likely time very well spent. “Asset allocation is a way of instilling discipline in a part of our lives that we often find very stressful,” says McGregor. “If you can reduce that stress, it improves the odds that you will stick to your long-term goals.”