The most important piece of your investing strategy


When choosing an investment strategy for your long-term goals, there’s no one-size-fits-all with regard to proper diversification. Vanguard investing experts Bryan Lewis, Frank Chism, and Matt Piro explain why investing according to your risk tolerance can be more important than diversification.

Notes:
All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.
© 2016 The Vanguard Group, Inc. All rights reserved.


TRANSCRIPT

Jon Cleborne: So Richard, from Windsor, Massachusetts, said, “Diversification, it feels like it’s a seesaw. One side goes up, the other side goes down. Has anyone really run the numbers and compared a diversified portfolio versus an all-stock portfolio?” So, Frank, I think you guys have actually run the numbers on this, so.

Frank Chism: We have run the numbers, yes, and I’ll pull a chart up in just a second. But, Richard, it’s an excellent point. I mean, when you originally hear about diversification and you hear, well, if one thing goes up, I want to have something else in my portfolio that goes down. Or if this goes down, I want this to go up. And if that happens in exactly the same proportion, then to Richard’s point, you probably don’t get anywhere, right. But the real thing of it is that over the fullness of time, an all-stock portfolio will do better. There’s something we talk about in the markets is that there’s what we call an equity risk premium. And all that really means is people have to get paid more to hold equities because stocks have more volatility. Bonds are by nature not as volatile as stocks are. So if I’m going to issue stock as a company, and you three guys are going to buy that stock, you want to be compensated better than if you’re going to buy a bond from me because the bond’s just going to pay you occasionally; the risk is much lower. So to answer your question, if you hold it forever, equities tend to do better, stocks tend to do better. The question is the volatility is really very, very high. So most investors and, again, this is kind of a behavioral aspect of it, most investors aren’t able to stomach that kind of volatility, particularly as you get closer to needing to use the money. And then the bonds, if you hold bonds forever, bonds over the last 15–20 years have done really remarkably well, but longer-term they should not do as well. But if we could go to our diversification chart, we can show you quickly. So what we’ve done with this chart is we’re just trying to show, say you started with roughly $100 at the beginning of 2007, and we go into the crisis of 2008. The dark blue line is 100% stocks, and you can see that line goes down the furthest, clearly; it went down about 40% that year. A 50/50 stock/bond portfolio went down significantly, but not nearly as bad. And a 30% stock, 70% bond portfolio went down quite a bit as well, but did the best of those three. Now over the fullness of time, as you come out of that, as you can see from our chart, 100% stock portfolio is going to recover more quickly because, as the market recovers, it has more risk to it and it’s going to do what you see here, is it’s actually going to catch up and go past the balanced portfolio. But the reason we talk constantly about balance and the question earlier came up, it’s a good one, what do we mean by that, is what is your ride from A to B? And that’s really the key to being in a balanced portfolio, is what does that ride feel like? And do I want my ride, do I want to go up 20% one year and down 30% the next year, and then up 10% the next year, or do I want to kind of be somewhere in the middle? And as the chart shows, that’s really what a balanced portfolio does for you. So to answer your question, if you could stomach 100% stocks and you have 25, 30, 40 years, fine. Most people, their time horizon may not be long, and it’s a wild, wild ride. And depending on when you decide to get off the ride, if you have a 40% decline the year before you went off, that’s the risk you run.

Bryan Lewis: And it also assumes that in that chart that you’re rebalancing, right, on the way down. A lot of investing, it’s emotional, right. It’s easy to, and this is what clients will come to me for, is when the stocks are down or if bonds are down, it’s easy to want to get out of that and go into something that’s doing well for that year. But it’s very, very important, critical to your success when it comes to investing over time to stick with your plan, rebalance accordingly. And as an advisor, what we would look for is actually not to sell something that’s underperforming, it’s actually probably buy more of that and really follow the old sell high, buy low concept. So that’s really what I’ll help my clients work through and it will allow the portfolio to rebound more quickly if you’re being disciplined in a down market.

Matt Piro: Yes, I think that’s one of those things that’s so powerful about that chart is if you think about if you were able to be disciplined, you can see, I mean, yes, there was a pretty significant drawdown, but then there was a huge bull run. And, you know, for the vast majority of folks, if they were able to stay fully invested, they made it all back up plus a good bit more. But if you happen to get a little bit spooked along the way and you bailed out too early, a lot of investors didn’t ride that back up, and that’s one of the unfortunate things. It’s why discipline becomes so important.

Important information

All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
Investments in bonds are subject to interest rate, credit, and inflation risk.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.
© 2016 The Vanguard Group, Inc. All rights reserved.