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3 reasons to revisit your asset allocation strategy

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A disciplined approach to investing, along with rebalancing as needed, can help you pursue your goals in up — and down — markets.

When the markets are going gangbusters, most people feel confident in their investing strategy. But when markets change and your portfolio starts to lose value, it can be easy to panic and wonder whether you’ll get back on track to meet your goals.

For many investors, that really hit home in early 2020, when stocks around the world dropped dramatically in response to uncertainty concerning the coronavirus pandemic. In the U.S., it marked the fastest and sharpest drop into bear market territory the Dow Jones Industrial Average had ever experienced.1 But even minor bouts of volatility can unsettle investors.

“Your long-term asset allocation strategy acts as a roadmap to help guide you through every kind of market.”

- Marci McGregor, managing director and senior investment strategist, Chief Investment Office, Merrill and Bank of America Private Bank

It’s at times like these that your asset allocation strategy — or the percentage of your portfolio you’ve chosen to devote to different assets such as stocks, bonds and cash — can provide useful perspective. “Your long-term asset allocation strategy acts as a roadmap to help guide you through every kind of market,” says Marci McGregor, managing director and senior investment strategist in the Chief Investment Office for Merrill and Bank of America Private Bank.

The asset allocation that’s most appropriate for you is shaped mainly by four key factors that you’ll want to consider: your financial goals, time horizon, comfort with risk and need for liquidity, or access to readily available cash. And it will likely change as you go through life. Younger investors might consider investing more heavily in riskier assets like equities, since they have time to make up for market downturns. Meanwhile, someone near retirement may want to have more cash and other less risky investments to help buffer against losses in equities. You’ll also want to revisit your allocations on a regular basis and make adjustments as needed.

Below, McGregor points to three potential benefits of having a thorough asset allocation strategy, and why it’s never too early, or too late, to get started.

Helping you ‘stay the course’ in volatile markets

“When markets are volatile, asset allocation can really shine,” notes McGregor. When you have an asset allocation strategy that aligns with your risk tolerance, time horizon and liquidity needs, you’ll be more likely to stay the course and keep focused on your goals. Why is that important? “History shows that pulling out of the markets when they are down can put you at risk of missing out on the subsequent rebounds that have always followed market declines.”

It’s about time in the markets, not timing the markets

Missing out on a just a few of the best days between 2005 and 2019 would have hurt your total return.

The total period of investing produced a 9% annualized return of $36,418. Missing the best 10 days produced a 4.13% annualized return of $18,358. Missing the best 20 days produced a 1.17% annualized return of $11,908. Missing the best 30 days produced a negative 1.35% annualized return of $8,150.

Source: Standard & Poor’s 500®Index, Dec. 31, 2019. Average annual returns are based on the S&P 500 Index from Dec. 31, 2004, to Dec. 31, 2019. Large-capitalization stock performance is measured by the S&P 500 Index, an unmanaged index considered to be representative of the U.S. stock market. Prices of common stocks will fluctuate with market conditions and may involve loss of principal when sold. Results assume reinvestment of all distributions, including dividends, earnings, and expenses, and are not indicative of any past or future returns of any investment. It is not possible to invest directly into an index. This is a hypothetical example. Past performance is no guarantee of future results.

“The best days often come soon after the worst,” says McGregor. And missing those days can be costly. In the 15 years through the end of 2019, if you missed out on the 10 best days for U.S. stocks — not weeks, not months, but days — your annualized return was about half of what it would have been if you stayed invested.

Minimizing risk through diversification

Because bonds often move in the opposite direction of stocks, they help to minimize the effects of a down market, says McGregor. An allocation that balances riskier investments, like growth or small-cap stocks, with lower-risk investments, like high-quality bonds, can potentially offer long-term growth, perhaps with less return, without putting your entire portfolio at risk. But diversification means more than spreading your investments across different asset classes; it also means choosing a broad selection of investments within the various asset classes, including stocks and bonds.

“When markets are volatile, asset allocation can really shine.”

- Marci McGregor, managing director and senior investment strategist, Chief Investment Office, Merrill and Bank of America Private Bank

Within the universe of bonds, for example, there are different sectors with varying degrees of risk, from U.S. Treasury bonds (low risk) to investment grade corporate bonds (a bit riskier) to high yield bonds (with risk often comparable to stocks). You might also want to consider geographic diversification, by layering in some investments outside of the United States. Each of these types of bonds offers different fee and expense structures and potentially higher or lower returns, depending upon its level of risk.

A roadmap for regular rebalancing

As time goes on, your portfolio will naturally “drift” from its initial target allocation, favoring assets that have been experiencing stronger returns.

How your asset allocation could change over time

Consider a somewhat cautious investor who, at the end of 2008, chose a “moderate” level of risk for her portfolio. Even with the dramatic decline in the stock market in March 2020, by the end of the following month, her allocations and her risk level looked quite different from her preferred allocation. This exposes her to more risk than she’s comfortable with.

A rotating pie chart displays the following asset allocations: December 31, 2008: A moderate risk portfolio of 35% bonds, 5% cash and 60% stocks. April 30, 2020: A high risk portfolio of 18% bonds, 2% cash and 80% stocks. Source: Chief Investment Office, April 2020.

This illustration is hypothetical and does not reflect specific strategies we may have developed for actual clients. It is not intended to serve as investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Results will vary, and no suggestion is made about how any specific solution or strategy performed in reality.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss.

Resetting your asset allocation to its original proportions — a process known as rebalancing — can help you make more measured decisions about when to buy and sell investments, as opposed to trying to time the market. You can consider rebalancing on a set schedule, say reviewing your allocation status every quarter or annually — known as periodic rebalancing — or whenever an asset strays outside of a given range, for example 5%, from your target — known as tolerance band rebalancing. Whichever option you choose, be sure to set aside time on a regular basis — such as monthly, quarterly or annually — to review your allocation and make adjustments as needed.

Over the long term, rebalancing can be used as a tool to reduce volatility in your portfolio. An analysis by the Chief Investment Office found that from 1992 to 2019, a portfolio of 50% stocks and 50% bonds that was periodically rebalanced was about 20% less volatile than a portfolio that wasn’t rebalanced. During that stretch, the worst period for the rebalanced portfolio was a 25% drop, compared with a 31% drop for the portfolio that wasn’t rebalanced.

Arriving at an asset allocation you feel is appropriate for your situation takes some time and planning. But given what’s at stake, that’s likely time very well spent. “Asset allocation is a way of instilling discipline in a part of our lives that we often find very stressful,” says McGregor. “If you can reduce that stress, it improves the odds that you will stick to your long-term goals.”

Learn more and take action

  • Watch this video for more insights on asset allocation.
  • When choosing how to invest, ideally you should balance the amount of investment risk you can comfortably tolerate with the potential return you’re seeking. Use our risk assessment questionnaire to help identify your risk profile and get a suggested asset allocation mix.
  • If your 401(k) plan is with Merrill, visit Benefits OnLine® to manage your investments.
 
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1 “Dow Jones Industrial Average’s 11-Year Bull Run Ends,” The Wall Street Journal, March 11, 2020.

Information is as of 07/13/3021.

Opinions are those of the author(s), as of the date of this document and are subject to change.

Past performance is no guarantee of future results.

The Chief Investment Office (CIO) provides thought leadership on wealth management, investment strategy and global markets; portfolio management solutions; due diligence; and solutions oversight and data analytics. CIO viewpoints are developed for Bank of America Private Bank, a division of Bank of America, N.A., (“Bank of America”) and Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S” or “Merrill”), a registered broker-dealer, registered investment adviser and a wholly owned subsidiary of Bank of America Corporation (“BofA Corp.”). This information should not be construed as investment advice and is subject to change. It is provided for informational purposes only and is not intended to be either a specific offer by Bank of America, Merrill or any affiliate to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service that may be available.

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss.

Investments have varying degrees of risk. Some of the risks involved with equity securities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Small cap and mid cap companies pose special risks, including possible illiquidity and greater price volatility than funds consisting of larger, more established companies. Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets. Bonds are subject to interest rate, inflation and credit risks. Investing in lower-grade debt securities (“junk” bonds) may be subject to greater market fluctuations and risk of loss of income and principal than securities in higher rated categories. Treasury bills are less volatile than longer-term fixed income securities and are guaranteed as to timely payment of principal and interest by the U.S. government. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration.

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