A Great Year For Balanced Portfolios

by: Dale Roberts

2013 was an incredible year for the stock markets around the globe (well most markets). The S&P 500 had one of its best years in many decades moving up some 32% when we factor in dividends. The developed international markets (NYSEARCA:EFA) increased by over 21%. My home market of Canada (NYSEARCA:EWC) was up about 10% though U.S. investors would have taken a currency hit bringing down that Canuck return to the area of 5%. Canadian investors invested in U.S markets saw a currency premium.

Given that, investors who were "all in" with pure stock portfolios were likely treated to incredible portfolio saving (decade saving) returns in 2013. And U.S. investors who had a home bias were "rewarded" for that lack of diversification. Of course U.S. investors were punished in the period of 2000-2009 if they were sticking close to home with their portfolios.

And it was a fantastic year for the Balanced Portfolios. A Balanced Portfolio will essentially give up some long term total return in return for much lower volatility of the broader markets. There are two main reasons to hold a Balanced Portfolio (that is a mix of stocks and bonds and perhaps cash and other asset classes). One of course as mentioned is to lower portfolio volatility due to the basic fact that the investor cannot handle the wild swings of the broader stock markets. Another reason is time horizon. If an investor is in the drawdown phase (harvesting their investments for spending) they need a certain amount of price protection to lessen the need to sell assets to fund that retirement. While markets will beat inflation over most periods we all know it's not a straight line up. In years where the market offers a severe correction, an investor in the drawdown phase would have to sell more assets. Protecting the overall value of your portfolio protects the drawdown factor.

With the equity markets delivered unusual returns, that translated into incredible returns for the Balanced Portfolio. A typical balanced portfolio of 60% stocks and 40% bonds would have delivered a return of 18% in 2013. A very simple portfolio mix could use (NYSEARCA:SPY) for equities and the broad based bond ETF (NYSEARCA:AGG). Of course those are dreamy returns for an investor who is managing risk. And that comes in a year when the bond markets (AGG in this case) delivered a negative return of -2%. As I wrote early in 2013 in this article - "Asset Allocation is Alive and Well". The balanced portfolio never goes out of style and we should never look at stocks and bonds in isolation. 2013 was a great year for the Balanced Portfolio in a year where we did see bond prices take a sizeable hit. Yields on 20-year plus Treasuries spiked in early summer. Was that a head fake, or a warning shot? No worries on either count for the investors in balanced portfolios. Once again, the incredible dynamic between stocks and bonds did their magic. That is likely to continue.

The traditional Balanced Income portfolio that I suggested in this article, The Ultimate Income Portfolio, also had a great year. The Income Portfolio consists of Vanguard's High Dividend ETF (NYSEARCA:VYM) at 50% with Guggenheim's Multi-Asset class ETF (NYSEARCA:CVY) at 35% and the high yield bond ETF (NYSEARCA:HYG) at 15%. That portfolio would offer a very generous current yield in the area of 4.3% and it delivered a total return of 22.6% in 2013.

Not only that, even the most conservative of Balanced Portfolios could have seen some very decent returns in 2013. Here are those historical returns to end of 2013.

We can see that the Balanced Income Portfolio (with 70% bonds and 10% each of U.S., International and Canadian equity markets) earned over 6% in 2013. The traditional balanced portfolio with 60% equities and 40% bonds had a blowout year with a 14.7% return. And the Balanced Growth Portfolio (25% bonds) delivered over 19%.

Full disclosure, my new monies for registered retirement and tax free accounts are going into the Balanced Portfolio. Could I mimic the Balanced Portfolio with ETFs and keep my fees even lower? Yes. Do I have the discipline to follow the formula and rebalance on a quarter basis without thinking? No. I will pay a little extra for that forced discipline. Also I do get some free monies from ING Direct with a matched employer contribution retirement plan. Financial Planning 101 says we should always take the free monies.

Here are the recent historical returns for one of our RSP (registered retirement accounts). They show income and total return growth.

In 2013 my very conservative Balanced Portfolios delivered in the area of 9-12%. Much better than the previous year.

Those numbers are impressive considering that the bond markets had an off year, and the Canadian markets are still underperforming the U.S. and International markets. Once again that is the magic of diversification. While major stocks markets will usually fall together in a correction, certain markets and regions can outperform in the bull scenario. 2013 was a perfect example of when investors can profit from International Diversification. I would then suggest that U.S. investors add in some international diversification by the way of EAFE and perhaps a sprinkling of individual countries such as Canada.

In my own self-directed Balanced Portfolios I practice the Cranky Maneuver where I take all of the income from various ETFs and direct that income to the rising income stream of my Canadian Dividend ETFs and Vanguard's VYM. In 2013 I also made attempts to fix my Canadian home bias - I'll admit to being scared off of the U.S. markets in 2009 or earlier. Sorry, I wasn't sure that you'd make it. And I'm not even sure that you applied the right medicine, but what choice does an investor have but to invest in the great companies in the world's largest economy? So in 2013 I did a rebalancing of sorts to add more U.S. exposure in those self directed accounts. I was also way too defensive with overexposure to bonds that would limit potential for modest total return. Those accounts are still quite defensive with just over 50% in equities and the rest in bond ETFs.

The rebalancing to add more equity exposure allowed me to generate some modest gains, though the addition of U.S. indexes and dividend ETFs eliminated my income growth for the year. My Canadian stock ETFs offer a much higher yield. I have created a portfolio with an incredibly low beta, but at times it can have incredibly low returns. I learned that one can certainly be too conservative if they want to participate even modestly in the stock market gains. I am still too conservative of course, I will gradually move my asset mix to that sweet spot of 60-40 by directing income to equities. But to tell you the truth I have been waiting for that equity market correction that simply has not yet arrived to make a significant rebalancing. Note to self: Never try to time the market even in modest way. If we investors have a mistake to fix, we should fix it now instead of waiting for an "opportunity".

It was a great year for the Balanced Portfolio. I can't guarantee or predict that 2014 will be just as fruitful, but we do know that over longer periods investors in Balanced Portfolios have been rewarded with very generous inflation beating returns. That is likely to continue. The reason to hold bonds and create Balanced Portfolios never changes for those investors who want or need to manage risk or require portfolio price protection.

As always and perhaps more than ever - asset allocation is alive and well.

Disclosure: I am long SPY, EFA, DIA, EWC, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Dale Roberts aka cranky is a Streetwise Coach at ING Direct Mutual Funds. The Streetwise Portfolios offer index-based complete portfolios to Canadians. Dale’s commentary does not constitute investment advice. The opinions and information should only be factored into an investor's overall opinion forming process.