Despite recent market turmoil, investors should not hastily abandon the balanced portfolio, which typically consists of a 60% allocation to equities and a 40% allocation to bonds. This investment model provides diversification and aims to mitigate the impact of price volatility. Although the recent market swings have affected both asset classes, it is important for investors to take a long-term perspective.
During the past week, fears about the Federal Reserve’s rate policy caused upheaval in both the equity and fixed income markets. The 10-year Treasury yield reached levels not seen since 2007, raising concerns of a potential move towards a 5% benchmark rate. The iShares Core Growth Allocation ETF (AOR), which maintains a 60/40 split, experienced declines as well, dropping about 1.8% this week.
In similar fashion, the 60/40 portfolio suffered in 2022 when equities and bonds both declined. Despite this, financial experts recommend maintaining the same long-term asset allocation strategy that has been effective in the past. Blair duQuesnay, a certified financial planner, advises investors to look beyond short-term market movements and focus on their long-term goals.
While rising inflation and interest rates were responsible for the considerable decline in bond prices last year, the current market disturbance seems to be connected to uncertainties surrounding the Fed’s future policy. Roger Aliaga-Diaz, global head of portfolio construction at Vanguard, suggests that rates are unlikely to return to pre-pandemic levels, resulting in a higher floor for the 10-year bond. Despite the initial pain for investors, Aliaga-Diaz believes that correlations will eventually return to normalcy.
Investors need to consider the potential income opportunities that higher yields offer over the long term, rather than letting short-term price declines overshadow these prospects. Blair duQuesnay emphasizes that the current aversion to bonds is surprising, considering the attractive yields they currently offer. Instead of selling bonds as prices fall, investors should assess their bond duration. DuQuesnay advises allocating to bonds with longer average duration, allowing investors to benefit from possible rallies in the bond market.
The 60/40 portfolio, although subject to periods of volatility, has historically delivered an average annual return of 6% over a 10-year period. Investors should view the current market turbulence as a reminder of the challenges involved with this strategy. This may also be an opportune time for investors to reassess their risk tolerance and make adjustments accordingly.
In addition, investors can take advantage of tax-loss harvesting to offset gains and reduce their tax liability. By selling losing positions in their portfolios and reinvesting in other assets that align with their long-term goals, investors can optimize their tax situation. It is crucial to consult with a tax professional to ensure compliance with regulations and avoid violating the wash sale rule.
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Definitions:
- Balanced Portfolio: An investment strategy that maintains a mix of assets, typically 60% in equities and 40% in bonds, with the aim of achieving diversification and minimizing risk.
- Diversification: Spreading investments across different assets to reduce exposure to any single investment or asset class.
- Equities: Ownership shares in a company, also known as stocks or shares.
- Bonds: Debt securities issued by governments or corporations to raise capital. Bondholders receive regular interest payments and the return of the principal amount upon maturity.
- Fixed Income: Investment products that pay a fixed stream of income, such as bonds and bond funds.
- Asset Classes: Different categories of investments, such as equities, bonds, real estate, and commodities.
- Duration: A measure of a bond’s sensitivity to changes in interest rates. Bonds with longer durations are more sensitive to rate changes.
- Tax-Loss Harvesting: Selling investments that have declined in value to offset capital gains and reduce taxable income.
- Wash Sale Rule: The IRS rule that prohibits investors from claiming a tax loss on a security if they purchase a substantially identical security within a 30-day period before or after the sale.
