The search for balance – with a bit of help from Einstein
It’s Albert Einstein’s birthday next week.
The German-born theoretical physicist was one of the greatest and most influential scientists of all time.
Einstein was visiting the United States on a study tour in 1933 when Hitler came to power. Sickened by the Nazi programme to exterminate his fellow Jews, Einstein remained in the States and was granted American citizenship.
The Nazis responded by turning his family home into a Hitler Youth Camp, and burning his personal effects.
In the US, he developed a reputation for being a bit wacky. He refused to wear socks, took his small terrier on speaking tours, and spontaneously played the violin to “kickstart” his mental processes.
He also came out with some great existential quotes. One of my faves is “Life is like riding a bicycle – to keep your own balance, you must keep moving forward”.
The quote came to mind recently when I received my monthly Kiwisaver statement.
January was a cracking month for the markets. In fact, the whole last 12 months has been a stunner.
After a 20.3% rally over 2023, the markets added another 3.9% in January. So, for someone invested solely in global equities, they would have enjoyed a January to January gain of over 24%. Not a bad little earner.
The US S&P 500 is now at an all-time high, sitting at over 5000 at the time of writing, thanks to strong economic data in the US, and some stellar growth from global internet stocks, including the “magnificent seven”.
Virtually all Kiwis have exposure to global stocks in their investment portfolios, be it through a Kiwisaver provider or through managed funds and direct investments.
And after taking a bit of a bath for much of 2022, those investors will be now looking at their balances with more of a smile on their faces. Particularly if they held their nerve as markets fell.
If they had $100,000 in passive global equities 18 months ago, that would be worth $143,000 today. A handy gain of 43%.
They say the only thing harder than holding your nerve when markets go down is to remember to sell when markets go up.
But in this case, that’s what’s likely to be needed for a person who wants to maintain a balanced portfolio of assets that reflects their risk profile.
So how does that look in real life?
If the person who put $100,000 into global equities 18 months ago had put another $100,000 into bonds or term deposits at the same time, chances are that this $100,000 would be worth about $106,000 after tax.
Which means they would go from a total investment portfolio of $200,000 split 50/50 between growth assets (equities) and income-producing assets (bonds), to a $250,000 portfolio split 60/40 growth to bonds. Wait a bit longer and that could be more like 70/30.
Assuming their risk profile had not changed, this would mean they ended up being overweight in riskier growth assets. Which means a bit of rebalancing is required.
Portfolio rebalancing is important for two reasons.
First, it’s good risk management. Every person has a risk appetite for how much volatility they are happy with. Typically, this is related to their investment time frame. A 20-year-old investing for retirement at 65 has 45 years to smooth out volatility. A 60-year-old has a lot less time to ride out cycles of volatility. So rebalancing ensures they are aren’t caught with an overly risky portfolio.
The second reason is that rebalancing can help to give you improved returns. If you’ve got several different growth investments which deliver similar long-term returns, some will be performing well and others poorly. Then, as part of rebalancing, you can choose to sell the performer and perhaps buy more of the underperformer.
In this case, you are selling high and buying low, which is the ultimate goal of investing.
If you’ve got all or most of your investments in a balanced fund, then all this is taken care of for you. The fund manager will have tolerance thresholds which trigger a rebalance once a fund moves too far away from the desired asset allocation. So you can relax.
But if you do your own direct investment as well, then now might be a good time to take a look at your overall asset allocation relative to your investment goals. Do a quick calculation of all your growth assets (shares, indexed funds etc), then your income-producing assets (term deposits, bonds, etc), and work out the ratio.
Then decide if that ratio is right for you, and if it gives you enough time to ride out the highs and lows of volatility to reach your own investment goal.
Going back to Einstein’s advice, to keep your own balance you must keep moving, and that includes ensuring that your balance of assets is right to get you to your destination. Mike O’donnell is a professional director, writer and strategy adviser, and a regular opinion contributor. He is not an investment adviser. Every investor should take professional advice before undertaking investment decisions.