After two bear markets in the first 10 years of the 21st Century, investors now seem to understand that stock market losses can be deep. Bonds offer relative safety, but low yields may not offer enough income for many investors who are worried about stock market volatility. all weather investing looks beyond the typical stock/bond/cash portfolio in an effort to benefit from market gains, while seeking some protection of capital on the downside.

SEE: 4 ETF Strategies For A Down Market and Exchange-Traded Funds

When stock markets dipped in the 1990s, analysts called it a correction and individual investors viewed it as a buying opportunity. From 1982 through 1999, buy-and-hold had been the king of investment strategies, as the S&P 500 delivered an annualized return of over 18%. Stock investors were reminded of the meaning of risk in the next 10 years, as those two bear markets led to an annualized return of -0.99% a year through the end of 2009. Realizing that financial storms can disrupt retirement plans, some investors considered the safety of bonds to provide steady income, unfortunately triple-A corporate bond yields were falling over that same time and yielding only 5.31% on average at the end of 2009. Safe Treasury bonds hovered near 3%.

In this environment, some investors became familiar with the idea of all weather investment strategies, which are designed to capture steady gains and limit volatility. The unpredictability of returns is one definition of volatility. When stocks fell more than 50% after the top in 2000, many 401k investors were forced to rethink their retirement plans. The recovery that began in 2002 had some investors back to where they started in five years, but the declines of 2008 and 2009 presented yet another setback, and many portfolios ended the decade at about the same level as where they stated.

Volatility can be decreased by diversification. One of the simplest all weather techniques is to create a balanced portfolio with 60% invested in a broad stock market index fund and 40% invested in bonds. During the lost decade that ended in 2009, one study found that this approach would have yielded an annualized average return of 2.6% a year.

Current-Day Analysis
This shows that adding asset classes can help to reduce risk. Unfortunately, many investors have failed to consider options besides stocks and bonds. Even the most adventurous may include a fixed allocation to gold and consider themselves well-diversified. Exchange-traded funds (ETFs) offer individual investors access to markets all over the world, and some of these funds offer access to asset classes that once required large investments. Perhaps most importantly, global asset class diversification could have helped deliver profits in the first decade of the 21st Century.

SEE: Why ETFs Are A-OK

Broadly speaking, there are at least 12 different asset classes - U.S. large-cap, mid-cap and small-cap stocks; foreign stocks in developed and emerging markets; corporate, government, foreign and inflation protected bonds; real estate; money market and commodities. ETFs can be used to access each of these classes.

Ask the Experts
Dr. Craig Israelsen, a professor at Brigham Young University, has shown that buying those 12 different classes can help investors achieve average returns that almost match stock market returns while having about the same level of volatility as an all-bond portfolio.

He maintains a part of the portfolio in cash, and found a model portfolio would have doubled in value using ETFs. This result relied on monthly rebalancing, restoring each position to their original allocation percentages at the end of each period. He also shows that less frequent rebalancing, done even as seldom as annually, can beat a simple buy-and-hold investment in stocks.

Nobel Prize-winning economist Burton Malkiel studied a diversified mutual strategy and found that an investor could have almost doubled his money from 2000 to the end of 2009 by using index funds. He looked at broadly based, low cost index mutual funds that focused on U.S. bonds, U.S. stocks, developed foreign markets, stocks in emerging markets and real estate securities. ETFs can offer lower costs to access each of these areas. That is a significant advantage to the long-term all weather investor. An ETF expense ratio may be half as much as the expense ratio of a mutual fund and the difference in expense ratios increases annual returns.

The work of Mebane Faber demonstrates that moderately active management can help investors avoid the worst of bear markets. Faber looked at five asset classes - U.S. stocks, foreign stocks, real estate, commodities and the U.S. 10-year Treasury bonds. He used a simple buy rule, holding the asset only when it was above its 10-month moving average.

The moving average is designed to look beyond the short-term trends within price data and help investors spot the longer-term trend. Faber's study assumes that you only own the asset class when it is on a buy signal. When prices fall below the 10-month average, you move to cash for that portion of the portfolio. The results are impressive, an average annual return of 11.27% from 1973 through the devastating bear market of 2008.

To implement any of these strategies, a wide range of ETFs can be used. Some examples include:

  • U.S. large-cap stocks: SPDR S&P 500 (NYSE:SPY)
  • U.S. mid-cap stocks: Vanguard Mid-Cap ETF (NYSE:VO)
  • U.S. small-cap stocks: Vanguard Small Cap ETF (NYSE:VB)
  • Foreign stocks in developed markets: Vanguard Europe Pacific ETF (NYSE:VEA)
  • Foreign stocks in emerging markets: Vanguard Emerging Markets Stock ETF (NYSE:VWO)
  • Corporate bonds: Vanguard Total Bond Market ETF (NYSE:BND)
  • Government bonds: Vanguard Intermediate-Term Government Bond Index Fund (NYSE:VGIT)
  • Foreign bonds: SPDR Barclays Capital Intl Treasury Bond (NYSE:BWX)
  • High yield bonds: iShares iBoxx High Yield Corporate Bond (NYSE:HYG)
  • Real estate: Vanguard REIT Index ETF (NYSE:VNQ)
  • Commodities: PowerShares DB Commodity Index Tracking (NYSE:DBC)

The Bottom Line
There are many other ETFs that can be used. Rebalancing can be done as little as once a year, as shown by Israelsen, or once a month, as shown as by Faber. Either way, all weather investing can be done in a relatively low maintenance portfolio.

SEE:Rebalance Your Portfolio To Stay On Track

Related Articles
  1. Professionals

    How to Sell Mutual Funds to Your Clients

    Learn about the various talking points you should cover when discussing mutual funds with clients and how explaining their benefits can help you close the sale.
  2. Mutual Funds & ETFs

    Top Three Transportation ETFs

    These three transportation funds attract the majority of sector volume.
  3. Professionals

    Fund and ETF Strategies for Volatile Markets

    Looking for short-term fixes in reaction to market volatility? Here are a few strategies — and their downsides.
  4. Investing Basics

    Tops Tips for Trading ETFs

    A look at two different trading strategies for ETFs - one for investors and the other for active traders.
  5. Investing

    How Diversifying Can Help You Manage Market Mayhem

    The recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
  6. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  7. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  8. Investing Basics

    5 Things To Ask Before Hiring A Financial Advisor

    Choosing a financial advisor isn't an easy task. Here's a list of the most important things to consider when planning for your financial future.
  9. Personal Finance

    How To Choose A Financial Advisor

    Many advisors display similar skillsets that can make distinguishing between them difficult. The following guidelines can help you better understand their qualifications and services.
  10. Investing Basics

    Diversifying Your Portfolio: 5 Easy Steps

    You can never be sure of what the market will do at any given moment. That’s why a well-diversified portfolio is so important.
  1. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  2. What are the risks of rolling my 401(k) into an annuity?

    Though the appeal of having guaranteed income after retirement is undeniable, there are actually a number of risks to consider ... Read Full Answer >>
  3. When are mutual funds considered a bad investment?

    Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>
  4. What fees do financial advisors charge?

    Financial advisors who operate as fee-only planners charge a percentage, usually 1 to 2%, of a client's net assets. For a ... Read Full Answer >>
  5. Can my 401(k) be seized or garnished?

    As long as your retirement funds are held in your 401(k) and you do not take them as distributions, your 401(k) cannot be ... Read Full Answer >>
  6. Are mutual funds considered retirement accounts?

    Unlike a 401(k) or Individual Retirement Account (IRA), mutual funds are not classified as retirement accounts. Employers ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  2. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  3. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  4. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  5. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
  6. Capitalized Cost

    An expense that is added to the cost basis of a fixed asset on a company's balance sheet. Capitalized Costs are incurred ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!