This… Is Why We Do It
By Douglas Drabik
When things are going great, everything seems so easy. Sometimes we go on cruise control, sometimes we want more and more of a good thing. Last week hopefully serves as a great reminder of why asset allocation is such an important concept to follow for portfolio composition.
Each component of asset allocation plays a significant role and instead of focusing only on the positive or negative characteristic of one or the other, it is essential to remember how all the components act as a combined unit. This is not a bash on equity securities or promotion of owning the isolated security of the month. Rather it is a reality check as to why we do what we do.
Growth assets over time should net higher returns. This is why they are classified as growth assets. To state the obvious, they grow our assets. They are an integral part of portfolios especially for beginning accumulations of net worth. Typically, this is in the earlier through prime stages of our careers and during times when earning potential is climbing and peaking. At some point in our journey we hopefully have grown our assets and accumulated significant wealth. This level and time frame is probably different for everyone but assumes at some point, NOT losing what has been accumulated becomes more important than continued growth.
This is where investment discipline is essential. Continued allocation to individual bonds can protect this accumulated wealth in a way no other asset class can. Last week serves as a reminder that the swings in a growth asset are what attract investors but also what can quickly generate fear. The DJIA fluctuated 6.5% from the high to the low over the last week. By comparison, the 10-year Treasury fluctuated 1.37%. Stocks have done what they do. Huge growth periods that over time will have a few pullbacks. Bonds have done what they do: provide predictable cash flow and a defined income.
The reason individual bonds provide this safety net is that they do exactly what they are intended to do from day one of purchase through the entire holding period (of course barring default). Regardless of interest rate moves and market volatility, the cash flow stream and income earned will not change. This works as long as the bond is held to maturity, rendering all market swings (good or bad) insignificant. The bond returns all its face value on the redemption date, again, regardless of where the market is on the redemption date. Do not mistake packaged products that contain bonds with individual bonds. One key protective characteristic is the stated redemption date.
So this is why we do it. Appropriate asset allocation is intelligent strategy!