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The case of the balanced portfolio

By Bob Landaas

Any way you measure it, 2012 was a really good year for most investors who were able to build balanced accounts.

It has been very interesting to analyze portfolios as of the end of the year, looking at returns relative to the amount of risk that was taken.

It was one of those unique years where we were able to capture 80%-90% of the upside of the market for only half the risk. Granted, the bond market helped us out. But that’s really what it’s all about – trying to make as much as you can without sticking your neck out.

What I’m talking about is Modern Portfolio Theory.

The broader market was up a little more than 13%, as measured by the Standard & Poor’s 500 Index. A lot of our clients did 11% or even better for the full calendar year. Think about that. You’re capturing 85% of the upside with betas on the portfolio of 0.5 or 0.6, indicating that you’re taking only 50% or 60% of the risk.

It’s really important to think about how to build portfolios the right way, where you’re trying to make as much as you possibly can and take as little risk as you have to.

Many people get that wrong. If the market goes up, they mostly want stocks. If the market goes down, they mostly want bonds. The results last year absolutely reinforce the notion that we’ve been working with for years at this company of how to mitigate risk.

You don’t need more than half of your money in stocks to do well.

You need the right stocks. You need the right bonds. But you have to ask at what point along the risk curve is the next unit of risk not worth it?

Last year clearly reinforced that whole concept of balance. When you review portfolios that had half stocks, half bonds, they captured most of the upside for just half the downside.

Because of the fixed-income market, it was a wonderful year for risk-averse investors who are properly balanced to capture so much of the upside. It normally doesn’t get that good. We’re normally capturing two-thirds of the upside for half the risk. To get so much of the upside for so little risk is pretty unusual.

Bob Landaas is president of Landaas & Company.

Steve Giles, vice president at Landaas & Company, emphasizes to clients the importance of balance in protecting their savings when markets go down.

Say you have two portfolios of $1,000 each. One is fully invested in the stock market. The other is split 50-50 between stocks and bonds.

If the value of stocks dropped 50%, the unbalanced portfolio would be worth $500 while the 50-50 plan would have $750. If stocks then went up 50%, the all-stock portfolio would return only to $750 while the balanced account would rise to $875.

“I always try to tell clients to look at the downside protection first,” Steve says. “Longer term, ultimately, what’s going to help clients is the not-losing-money part.”

(initially posted Jan. 24, 2013)

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