Risk versus Reward: How to Balance Your Portfolio for Long-Term Success
There is a saying in finance, there is no free lunch, which is true for most things. There is always a payment or trade off for something that you want, no matter what it is.
Investing is no different, you need to understand that investing can be volatile and it pays to know what the historical averages are. However, that does not mean you will have the nerve to hold on to something valuable when it is decreasing in value significantly when the stock market crashes.
Read on about risk v reward how it can lead to investing success, or even failure !
Let me know what you think.
Investing is all about the future, but having a solid understanding of the history of markets can provide clarity and confidence when dealing with uncertainty. One of the most important concepts in investing is the relationship between risk and reward, which measures how much return you can expect for taking on a certain level of risk.
In general, the higher the risk, the higher the potential reward, but also the higher the chance of losing money. Conversely, the lower the risk, the lower the potential reward, but also the lower the chance of losing money. However, risk and reward are not always proportional, and different asset classes can have different risk-reward profiles over time.
Historical Returns by Asset Class
One way to compare the risk and reward of different asset classes is to look at their historical returns over a long period of time. For example, the following table shows the annualized returns and standard deviations of several asset classes from 1985 to 2019. You can check out the Vanguard Asset Class tool to check out data from 1970 through to 2022 here.
Historical Returns by Asset Class - 35 years (1985-2019)
Data for the graph above on 34 years of returns and volatility for each asset class.
As you can see, stocks have historically delivered the highest returns, but also the highest volatility, among the asset classes. Bonds have offered lower returns, but also lower volatility, than stocks. Cash has provided the lowest returns, but also the lowest volatility, among the asset classes. Gold has been a volatile asset class, with returns that have varied significantly over time. REITs have been a relatively high-returning and high-volatility asset class, reflecting the cyclical nature of the real estate market.
However, these historical averages do not tell the whole story. The returns and risks of each asset class can vary significantly from year to year, depending on the economic and market conditions.
There is no clear pattern or ranking of the asset classes over time. Some years, stocks outperform bonds, cash, gold, and REITs, while other years, the opposite is true. Some years, emerging markets lead the pack, while other years, they lag behind. Some years, gold shines as a safe haven, while other years, it loses its lustre. Some years, REITs boom as property prices soar, while other years, they bust as property prices collapse.
How to Manage Risk and Reward in Your Portfolio
So, how can you use this information to balance your portfolio for long-term success? Here are some tips and strategies to consider:
Know your risk tolerance and return objectives over a time horizon. Before you invest, you should have a clear idea of how much risk you are willing and able to take, and how much return you need or want to achieve your financial goals based on a time period. Your risk tolerance and return objectives may depend on factors such as your age, income, expenses, savings, time horizon, and personality. You should also review your risk tolerance and return objectives periodically, as they may change over time.
Diversify across asset classes, sectors, geographies, and styles. One of the most effective ways to reduce your portfolio risk and increase your portfolio reward is to diversify your investments across different asset classes, sectors, geographies, and styles. By doing so, you can reduce the impact of any single asset class, sector, geography, or style on your portfolio performance, and benefit from the different sources of return that each one offers. For example, you can invest in a mix of stocks, bonds, cash, gold, and REITs, as well as in different industries, countries, and market segments, such as value, growth, and quality.
Adopt a long-term perspective and a disciplined approach. Investing is a marathon, not a sprint. You should focus on the long-term performance of your portfolio, rather than the short-term fluctuations of the market. You should also follow a disciplined approach to investing, such as using a buy-and-hold strategy, a dollar-cost averaging strategy, or a rebalancing strategy, to avoid emotional or impulsive decisions that may hurt your portfolio performance. By doing so, you can take advantage of the power of compounding, which can significantly enhance your portfolio returns over time.
Seek professional advice. Investing can be complex and challenging, especially in uncertain and volatile times. You may benefit from seeking professional advice from a qualified financial planner, who can help you design and implement a portfolio that suits your risk tolerance and return objectives, as well as provide ongoing guidance and support.
In summary, risk and reward are two sides of the same coin in investing. You cannot have one without the other. However, you can manage your risk and reward by understanding the historical performance of different asset classes, diversifying your portfolio, adopting a long-term perspective and a disciplined approach, and seeking professional advice. By doing so, you can balance your portfolio for long-term success.
Who else is enjoying the Stock Market Rollercoaster?
The Stock market can be a rollercoaster of a ride, full of uphill thrills, bumps and massive drops!
Only the brave of the brave can handle the ride, are you apart of the brave who is educated enough to stick with it?
Have you felt it yet? The emotional rollercoaster of the stock market, which has literally been going up and down like a yo-yo the last two months, but especially the last month.
The epic highs from last years massive bull run on the stock market left you feeling euphoric, like you could do no wrong.
Which started to slow down by the end of December, and then it picked up right where 2021 left off, hitting what was an all-time record for the ASX 200 (The index tracking the top 200 companies in Australia).
However, by the end of January, we almost saw a correction, where the market dropped significantly by 7-8%, but you would have thought, here is a buying opportunity, “Buy the Dip mentality.”
You would have thought, it will go back up anyhow…
And it did, actually re-gaining 4-5% and then Russia invaded Ukraine, where we saw another dip of 3-4%, driven by major uncertainty in the global economy.
ASX 200- Jan 4th, 2022 - Mar 24, 2022
The ASX 200 is still down nearly 3% from the start of the calendar year. What a ride!!
My portfolio returns for the Month of March
The returns and losses of my very own stock portfolio over the last month has been a hell of a ride, which left me doubting myself at the start of March.
Just looking at the graph’s above, you can see the volatility and it really does look like a rollercoaster track!
Being invested in the market truly has left you feeling like you have been on a ride, full of adrenaline and then the opposite, feeling down right silly and as if you had made a huge mistake.
Over the last month, some investors would have made some massive decisions, whether to buy, sell or hold…
Which given the current climate, the uncertainty in the world, the greater economy and what the future holds, these decisions have been truly difficult.
But, I for one have been enjoying the experience that is the rollercoaster of the stock market the last month. The choices that have needed to be made over the last month was easy for me, as I hope it was for you.
I found myself buying down more shares within the companies that I own in the massive drop in the market at the start of January.
Since Russia has invaded, I have been sitting pretty, where I got myself a bag of popcorn and have just enjoyed the ride.
Were there doubts? Of course there was, especially when my portfolio was showing losses of 15%…
However, what stopped me from selling down and jumping over to the smoother ride that would be the carousel (ie; cash or bonds), was the knowledge of history on the stock market and also knowing the Fundamentals of the businesses I had invested in!!
The stock market, over the course of 200 years, has seen more gains than any other asset!
Knowing this, it is an easy decision, because over the long term, the assets that are held will see returns. The other factor, whereby I know the underlying fundamentals of the business, has left me feeling safe and secure at night.
I have invested in companies that have a huge cash reserve, low debt and are profitable over the last two financial years. Not to mention, their Return on Equity (the return a company has on the equity they use to invest back into the company), has been holding strong at 8-21% over the last ten years.
Meaning, they are very unlikely to go bankrupt, and that management is good enough to ride the waves of war, inflation and much more.
Will some companies be a loss?
Sure, but that will be offset by the gains that other companies will be making over the next 5-20 years!
Which is why I for one have been revelling in the rollercoaster that is the stock market over the last three months.
And I hope you have too.
Ps.
Investing in the stock market is not for everyone and truly depends on your risk tolerance, as well as many other factors regarding your life. If you are thinking about investing in the market, please find a trusted and professional Financial Advisor who can help you navigate the mind-field that is the Financial Markets!
The pure fact of the matter is, it is about learning to control your emotions and figure out who you are as a person.
Until next time,
Take Back Control