Think Your Portfolio is Balanced? Think Again

Think You’ve Got a Well-Balanced Portfolio? Time to Take a Closer Look

You’ve probably heard plenty of conventional wisdom on the right balance of stocks versus bonds in a portfolio. When constructing your portfolio, whether on your own or with the help of a financial advisor, it’s probably one of the first questions you considered.

Stocks have a higher potential risk and higher potential reward, while bonds have historically been both less risky and lower-yielding. You know you need both, but what’s the right proportion? The answer depends on your age, personal risk tolerance, and investment goals.

Balanced portfolio protection chart

But whatever ratio you’ve landed on, you may have been taking on more risk than you realize—or want—on both sides of the portfolio. In a recent analysis of 1,500 portfolios with a 60% stocks/40% bonds allocation, the BlackRock Portfolio Consulting Services team found that a whopping 94% of these portfolios were taking on more risk than a 60%/40% combination of the S&P 500 and the Bloomberg Barclays U.S. Aggregate Bond Index.1

More equity risk

There are several reasons portfolios can have more equity risk than the U.S. market as a whole. For one, active mutual funds have historically pursued riskier investments as they have sought to beat the market.

Another factor is that many U.S.-based investors tend to have an entrenched home country bias – but while the U.S. has the reputation of being overall less volatile than, say, emerging markets, the lack of geographical diversification is a risk factor itself, especially since half the world’s market capitalization resides in non-U.S.-domiciled companies.

International stocks, while they may be more volatile on their own, are less correlated to the events that shape U.S. market movements – so, counterintuitively, adding these exposures that may be riskier on their own can potentially lower volatility in a portfolio overall.

If you’re looking to add to your international allocation, there are ways to seek to mitigate volatility. Looking to minimum volatility strategies, for example, may be one way to potentially reduce the risk of international markets.

More bond risk

Lack of appetite for global exploration can be a risk factor within bonds as well. But there are other factors at work. For one, many investors have shifted their fixed income portfolios towards credit risk, seeking protection from rising interest rates. The problem is that credit risk is generally correlated to the health of the overall economy – and hence, to the equity market.

Furthermore, a low-yield landscape has driven investors to higher-yield bonds in order to maintain some income – but this also drives up risk, and can increase correlation to equity markets. As a result, bond portfolios may no longer work as effectively as a counterweight to stocks.

So what’s an investor to do? The first step is taking a look at your portfolio, perhaps with your advisor, and look for sources of undesirable correlation. Take a look at your ratio of domestic-international equity allocations, as well as your credit risk versus duration risk allocations on the bond side.

But whatever you do, it’s important to consider staying invested – it’s one of the best things you can do for a portfolio in the long run.

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