By Kostya Etus, CFA, Senior Portfolio Manager, CLS Investments
There are several variables investors can control when investing, including the cost, time until withdrawals, how we react to volatility, and how much risk we take on. Unfortunately, we tend to focus most on returns, which we have no control over.
One of the most important elements investors can control is risk, and it can have a significant impact on returns. CLS focuses on measuring and targeting specific risk levels (Risk Budgeting). We do not make allocation changes based on market moves (performance chasing). By holding risk steady over the long term, we can match specific client needs and help control client emotions. Ultimately, CLS believes that keeping clients invested for the long run is the best way to achieve financial goals.
Additionally, we build globally diversified, balanced portfolios. A diversified approach can help defend against significant price drops in any one asset class. A consistent level of risk combined with a diversified approach results in a powerful matchup that is hard to beat. Take a look at the table below, which shows yearly risk and return for two portfolios starting in the year 2000:
- The diversified portfolio consists of 60% equities and 40% bonds, with the equity portion broken up into 60% U.S. stocks and 40% international stocks.
- The non-diversified portfolio is the S&P 500 Index.
- The diversified portfolio generally underperforms in the up years but outperforms in down years – a defensive approach (although not always the case as 2018 has shown).
- There were many more up years than down over the last 18 years. In fact, the average total return is higher for the non-diversified portfolio over this period. And yet, the annualized/cumulative returns and ending dollar value still favor the diversified portfolio. How can this be?
- It is because the risk of the diversified portfolio is so much lower; for the entire period it is 9% versus 15% – a 40% relative reduction in risk.
- For every down day that the diversified portfolio outperforms, it is able to compound returns and grow faster on the rebound.
- The result is a 14% higher cumulative return for the diversified portfolio. Translated into dollars, if you started with $10,000, the diversified approach results in an additional $1,400 in your pocket.
As a reminder, CLS builds Risk Budgeted, global, balanced portfolios to help investors succeed over time.