by
Badgley Phelps
| Sep 02, 2016
September 2, 2016
During times such as these, when stocks have generated gains for consecutive years, investors can grow complacent about the risks inherent in their portfolios. But just as you’d pack a balanced meal in your summer picnic basket, it’s critical to balance your investment portfolio by properly diversifying across stocks, bonds and other assets when you invest.
For your summer picnic and everyday eating, nutritionists recommend that you focus on fruits and vegetables, eat whole grains, vary proteins and consume less sodium, saturated fat and added sugars. Good portfolio construction is no different. When we develop investment strategies for our clients, our primary objective is to build portfolios that will provide sufficient returns that allow them to achieve their goals while minimizing the risks. Thinking of investments like picnic pickings is a good way to start that process.
Fruits and vegetables: safest investments
Bonds are the watermelon and summer corn in your picnic basket. They offer predictable cash flows and often rise in value when the economy performs poorly. Accordingly, they provide the conservative element within the portfolio which can lead to increased financial security. As an example, government bonds, also referred to as U.S. Treasury securities, are issued to help finance our national budget and are considered one of the safest investments in the world.
Whole grains: safe investments
Other types of bonds are considered safer than stocks, but are not considered as free of risk like Treasury securities. Government agency bonds are issued to finance activities supported by public policy, such as home ownership and farming. Investment grade municipal bonds are issued by states and local governments to finance their capital expenditures such as highways, bridges or schools. High quality corporate bonds also fit in this category. They are issued by companies that need cash for things such as new ventures, acquisitions, operations and stock buybacks. Given the higher risk of the bonds in this category, they borrow at higher interest rates compared to the U.S. Treasury.
Proteins: investments to balance
It is also important to diversify within each asset class. Simply adding balance to your investments can provide potential for growth while managing volatility and protection against market downturns. For example, adding stocks with unrelated or opposite drivers may reduce the risk in your portfolio without lowering your expected level of return. When we invest we include stocks of companies that are growing their earnings at a rapid pace but pay no dividends, as well as those with low growth rates and high dividends. Think of it like adding fried chicken to your picnic basket this week and grilled fish next week.
Fats and sugars: riskier investments
All investments are subject to at least some risk, but some are much riskier than others. Some of the riskiest investments are leveraged exchange-traded funds (ETFs), IPOs, options, futures and limited partnerships. Like the small dessert in your picnic basket, there can be a place—and a reward—for riskier investments. But they should be carefully evaluated. For our clients, we diversify within each of the stock and bond segments in an attempt to minimize those risks for which there is little or no reward. This approach increases the likelihood of a successful investment strategy and long-term financial health.
Is it time to evaluate your portfolio?
With the market near record highs, now is a good time to review whether your portfolio is properly allocated. Concentrated equity positions or portfolios that have not been rebalanced may have much more risk than you would think. Get in touch today to start a conversation about getting your portfolio in balance.
We may even pack a picnic.
