ACCOUNTS & TRADING
PREMIUM CONTENT & TOOLS
Fidelity Institutional Asset Management®
ACCOUNTS & TRADING
PREMIUM CONTENT & TOOLS
Posted:09/13/2019 by Fidelity Viewpoints
It's easy to find people with investing ideas—talking heads on TV, or a "tip" from your neighbor. But these ideas aren't a replacement for a real investment strategy.
We believe that you should have a diversified mix of stocks, bonds, and other investments, and should diversify your portfolio within those different types of investment. Setting and maintaining your strategic asset allocation are among the most important ingredients in your long-term investment success.
Work with your financial representative to give your portfolio a regular checkup. At the very least, you should check your asset allocation once a year or any time your financial circumstances change significantly—for instance, if you lose your job or get a big bonus. Your checkup is a good time to determine if you need to rebalance your asset mix or reconsider some of your specific investments.
The goal of diversification is not necessarily to boost performance—it won't ensure gains or guarantee against losses. Diversification does, however, have the potential to improve returns for whatever level of risk you choose to target.
To build a diversified portfolio, you should look for investments—stocks, bonds, cash, or others—whose returns haven't historically moved in the same direction and to the same degree. This way, even if a portion of your portfolio is declining, the rest of your portfolio is more likely to be growing, or at least not declining as much.
Another important aspect of building a well-diversified portfolio is trying to stay diversified within each type of investment.
Within your individual stock holdings, beware of overconcentration in a single investment. For example, you may not want one stock to make up more than 5% of your stock portfolio. Fidelity also believes it's smart to diversify across stocks by market capitalization (small, mid, and large caps), sectors, and geography. Again, not all caps, sectors, and regions have prospered at the same time, or to the same degree, so you may be able to reduce portfolio risk by spreading your assets across different parts of the stock market. You may want to consider a mix of styles too, such as growth and value.
When it comes to your bond investments, consider varying maturities, credit qualities, and durations, which measure sensitivity to interest-rate changes.
During the 2008–2009 bear market, many different types of investments lost value at the same time, but diversification still helped contain overall portfolio losses.
Consider the performance of three hypothetical portfolios: a diversified portfolio of 70% stocks, 25% bonds, and 5% short-term investments; an all-stock portfolio; and an all-cash portfolio. As you can see in the table below,1 a diversified portfolio lost less than an all-stock portfolio in the downturn, and while it trailed in the subsequent recovery, it easily outpaced cash and captured much of the market's gains. A diversified approach helped to manage risk, while maintaining exposure to market growth.
Source: Strategic Advisers LLC. Hypothetical value of assets held in untaxed accounts of $100,000 in an all-cash portfolio; a diversified growth portfolio of 49% US stocks, 21% international stocks, 25% bonds, and 5% short-term investments; and all-stock portfolio of 70% US stocks and 30% international stocks. This chart's hypothetical illustration uses historical monthly performance from January 2008 through February 2014 from Morningstar/Ibbotson Associates; stocks are represented by the S&P 500 and MSCI EAFE Indexes, bonds are represented by the Barclays US Intermediate Government Treasury Bond Index, and short-term investments are represented by US 30-day T-bills. Chart is for illustrative purposes only and is not indicative of any investment. Past performance is no guarantee of future results.
Why is it so important to have a risk level you can live with? The value of a diversified portfolio usually manifests itself over time. Unfortunately, many investors struggle to fully realize the benefits of their investment strategy because in buoyant markets, people tend to chase performance and purchase higher-risk investments; and in a market downturn, they tend to flock to lower-risk investment options; behaviors which can lead to missed opportunities. The degree of underperformance by individual investors has often been the worst during bear markets.
"Being disciplined as an investor isn't always easy, but over time it has demonstrated the ability to generate wealth, while market timing has proven to be a costly exercise for many investors," observes Ann Dowd, CFP®, vice president at Fidelity Investments. "Having a plan that includes appropriate asset allocation and regular rebalancing can help investors overcome this challenge."
To start, work with your financial representative to make sure your asset mix (e.g., stocks, bonds, and short-term investments) is aligned to your investment time frame, financial needs, and comfort with volatility. The sample asset mixes below combine various amounts of stock, bond, and short-term investments to illustrate different levels of risk and return potential.
Data source: Morningstar Inc., 2019 (1926–2018). Past performance is no guarantee of future results. Returns include the reinvestment of dividends and other earnings. This chart is for illustrative purposes only and does not represent actual or implied performance of any investment option. See footnote 2 below for detailed information.
The purpose of the target asset mixes is to show how target asset mixes may be created with different risk and return characteristics to help meet a participant's goals. You should choose your own investments based on your particular objectives and situation. Remember, you may change how your account is invested. Be sure to review your decisions periodically to make sure they are still consistent with your goals.
Once you have a target mix, you need to keep it on track with periodic checkups and rebalancing. If you don't rebalance, a good run in stocks could leave your portfolio with a risk level that is inconsistent with your goal and strategy.
What if you don't rebalance? The hypothetical portfolio shows what would have happened if you didn't rebalance a portfolio from 2006–2019: The stock allocation would have grown dramatically (see chart).
This chart's hypothetical illustration uses historical monthly performance from January 1997 through December 2018 from Morningstar/Ibbotson Associates; stocks are represented by the S&P 500 and MSCI EAFE Indexes, bonds are represented by Barclays US Intermediate Government Treasury Bond Index, and short-term investments are represented by US 30-day T-bills. Chart is for illustrative purposes only and is not indicative of any investment. Past performance is no guarantee of future results.
The resulting increased weight in stocks meant the portfolio had more potential risk at the end of 2019. Why? Because while past performance does not guarantee future results, stocks have historically had larger price swings than bonds or cash. This means that when a portfolio skews toward stocks, it has the potential for bigger ups and downs.2
Rebalancing is not just a volatility-reducing exercise. The goal is to reset your asset mix to bring it back to an appropriate risk level for you. Sometimes that means reducing risk by increasing the portion of a portfolio in more conservative options, but other times it means adding more risk to get back to your target mix.
Investing is an ongoing process that requires regular attention and adjustment. Here are three steps you can take to keep your investments working for you:
If you haven't already done so, define your goals and time frame, and take stock of your capacity and tolerance for risk.
Choose a mix of stocks, bonds, and short-term investments that you consider appropriate for your investing goals.
Stocks have historically had higher potential for growth, but more volatility. So if you have time to ride out the ups and downs of the market, you may want to consider asking your financial representative about investing a larger proportion of your portfolio in equities.
On the other hand, if you'll need the money in just a few years—or if the prospect of losing money makes you too nervous—consider a higher allocation to generally less volatile investments such as bonds and short-term investments. By doing this, of course, you'd be trading the potential of higher returns for the potential of lower volatility.
Once you have chosen an asset mix, research and select appropriate investments.
Working with a financial representative, we suggest regular maintenance for your portfolio. That means:
Achieving your long-term goals requires balancing risk and reward. Choosing the right mix of investments and then periodically rebalancing and monitoring your choices can make a big difference in your outcome.
1. Source: Strategic Advisers. Portfolio risk is measured using standard deviation, which is a statistical measure of how much a return varies over an extended period of time. The more variable the returns, the larger the standard deviation. Investors may examine historical standard deviation in conjunction with historical returns to decide whether an investment's volatility would have been acceptable given the returns it would have produced. A higher standard deviation indicates a wider dispersion of past returns and thus greater historical volatility. Standard deviation does not indicate how an investment actually performed, but it does indicate the volatility of its returns over time. Standard deviation is annualized. The returns used for this calculation are not load adjusted.
2. Historical returns for the various asset classes are based on performance numbers provided by Ibbotson Associates in the Stocks, Bonds, and Inflation (SBBI) 2001 Yearbook (annual update work by Roger G. Ibbotson and Rex A. Sinquefield). Domestic stocks are represented by the S&P 500® Index, bonds are represented by US intermediate-term government bonds, and short-term assets are based on the 30-day US Treasury bill. Foreign equities are represented by the Morgan Stanley Capital International Europe, Australasia, Far East Index for the period from 1970 to the last calendar year. Foreign equities prior to 1970 are represented by the S&P 500® Index.
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
Past performance is no guarantee of future results.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.
Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for investments that focus on a single country or region.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities). Fixed income securities also carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties. Lower-quality fixed income securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Foreign investments involve greater risks than U.S. investments, and can decline significantly in response to adverse issuer, political, regulatory, market, and economic risks. Any fixed-income security sold or redeemed prior to maturity may be subject to loss.
Indexes are unmanaged. It is not possible to invest directly in an index.
The S&P 500 Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.
The MSCI® EAFE® (Europe, Australasia, Far East) Index is a market capitalization-weighted index that is designed to measure the investable equity market performance for global investors in developed markets, excluding the US and Canada.
The Barclays US Intermediate Government Bond Index is a market value-weighted index of US government fixed-rate debt issues with maturities between one and 10 years.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
Equity performance is represented by the Standard & Poor's 500 Composite Index, an unmanaged index of 500 common stocks generally representative of the US stock market. S&P 500® and S&P are registered service marks of The McGraw-Hill Companies, Inc., and are licensed for use by Fidelity Distributors Corporation and its affiliates. Fixed income performance is represented by the Barclays Capital Aggregate Index. The Barclays Capital Aggregate Index is an unmanaged market value-weighted index representing securities that are SEC registered, taxable, and dollar denominated. This index covers the US investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. Past performance is no guarantee of future results. Performance of an index is not illustrative of any particular investment. It is not possible to invest directly in an index.