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INVESTMENT INSIGHTS FROM OUR EXPERTS

  • Writer's pictureThomas Poff, CFA

A Balanced Portfolio Generates Growth and Protects Against Downside

When most people think of an investing portfolio, maximizing gains is usually the sole objective. After all, investors want to buy low and sell high. But there’s more to building a balanced portfolio than maximizing upside gains.


It’s also imperative that a portfolio be diversified enough to help protect against downside risks, as well. One big question of course is how much risk should you take? For some, the answer is somewhere in the middle. Most people, however, just aren’t sure.


Balanced Portfolio

Understanding Risk and Returns


Returns are the profits generated from an investment while risk is associated with the possibility of lower returns or losses. And there is a correlation between risk and return.


The higher the risk, the greater the potential returns. That’s why investors love getting in on the ground floor of tech stocks. But there is the trade off. The greater the risk the greater the chances of realizing losses.


Conversely, the lower the risk level, the lower the returns. This is why investors also love blue-chip stocks. They’re industry juggernauts with products and services that people need and have a long history of generating strong financial results, even when we’re in a recession.


How Do I Evaluate Risk and Return?


Risk management and capital preservation are important parts of a balanced portfolio and they require investors to think about the bigger picture. This means looking beyond daily returns to longer-term gains fuelled by the entire portfolio. This can include stocks, bonds, RRSP, TFSA, pensions, mutual funds, life insurance, real estate, and inheritance. Even your age will be a factor in determining how you build a balanced investment portfolio.


Taken together, these investment options can radically change how an investor evaluates both risk/return and overall performance.


How Can I Generate Solid Returns with an Acceptable Level of Risk?


We’ve seen firsthand over the last number of years, just how quickly the stock market and economy can change. The pandemic created one of the fastest and steepest bear markets on record, followed by the shortest, fastest recovery in history. After hitting a record high in January 2022, the S&P 500 has trended lower, with stubbornly high inflation, rising interest rates, and fears of a recession weighing on investor sentiment.


After the dramatic moves over the last few years, many investors have taken to revaluating their portfolios. And it’s important to rebalance a portfolio. The economy isn’t static and neither is the stock market.


Half a century ago, the Dow Jones Industrial Average included Eastman Kodak, Sears, and F.W. Woolworth. Today, it includes Apple, Nike, Walt Disney, and McDonald’s. Two decades ago, Nortel was the biggest stock in the TSX, today it’s the Royal Bank with Shopify in the top five.


Your portfolio should change over time to reflect your goals, investing horizon, and comfort with risk and return. This will invariably result in potential returns changing over time too.


How Do You Measure a Portfolio’s Performance?


Logging the biggest gains is not the sole purpose of a sound financial strategy. It’s more important to build a diversified portfolio that can protect against downside as well.


Instead of your portfolio matching positive and negative returns from the TSX and NASDAQ or popular indices like the S&P 500 and Dow Jones Industrial Average, a balanced portfolio will experience less downside.


And that’s where perspective comes in. It isn’t difficult to generate gains when the markets are bullish. It’s a different story though when the markets are experiencing extreme volatility. A balanced portfolio can make it look like you’re missing out on massive gains when the stock market is ripping higher, but that same balanced portfolio can also protect from inevitable declines and recessions.

​Balanced Portfolio/Up & Down Markets

Stock Market

Balanced Portfolio

Bear Market (Tech Crash 2000-2002)

-40%

-17%​

Bull Market (Housing Boom 2002-2007)

171%

77%

​Bear Market (U.S. Financial Crisis 2007-2009)

-44%

-30%

Bull Market (2009-2020)

225%

204%

​Bear Market (Pandemic February/March 2020)

-37%

-22%

Total Return 2000-2020

184%

198%

As you can see in the above example, a balanced portfolio did not match the massive gains the broader stock market did during bull markets. At the same time, a balanced portfolio protected from the same kind of downside.


This doesn’t mean a balanced investment won’t experience some volatility, it does, but it should be limited. And because of the portfolio’s balance, it should also rebound more quickly too. As a result of this diversified strategy, over the long run, the portfolio can be expected to provide better growth.


What if There Is a Recession in 2023 or 2024?


Most analysts expect the Canadian and American economies to slip into a recession in the second half of 2023. This will have a direct impact on corporate earnings and helps explain why some economists believe the S&P 500 could fall anywhere from 20% to 40% over the coming quarters.


This is where a balanced portfolio shines. Conventional wisdom suggests that when the broader market rebounds from a deficit, investors will break even when the market recovers. But it’s a little more entailed than that.


After a 50% decline, a stock needs to climb 100% just to get back to where it was before the sell-off. It takes a lot for a stock’s market capitalization to double. Even after a 25% fall, a stock needs to rally 33%.


By preserving capital in a balanced portfolio, the return needed to recoup any losses is significantly lower than if the entire portfolio had been exposed to riskier assets. That preserved capital within a balanced portfolio can also be used to add excellent stocks beaten down during a crash or correction, at bargain prices.


Sharp Asset Management for Your Retirement Planning


With a long-term investing horizon, you don’t own the entire stock market. You have a balanced portfolio that is personalized to meet your unique risk/return needs. As a result, your objective isn’t to match or beat the market, instead a balanced portfolio helps you navigate the ups and down and reach your investing goals.


If you live in Mississauga, Toronto, or the GTA and would like to work with a private wealth management team that can help you create a balanced portfolio aligned with your objectives, speak with an investment counsellor at Sharp Asset Management.


Sharp Asset Management Inc. is an independent Portfolio Management firm that is 100% owner operated. We are not affiliated with any financial institution, securities firm or mutual fund company. As a result, our investment decisions are unbiased. Nor do we earn any commissions or fees on investments we choose on behalf of our clients.


All of our investment counsellors are charter financial analysts, the highest level of achievement, and have over 10 years of experiencing managing portfolios. To learn more about investing with Sharp Asset Management, contact us today.

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