When it comes to investing, success is largely within your control and doesn’t have to be as complicated as it looks. 

One way to reduce the stress and noise that is sometimes associated with making investment decisions, is to have the right mix of assets (such as shares or bonds¹) in your portfolio. We call this being balanced, which is one of our four investing principles and something we believe could have a bigger impact on your returns than anything else you do. 

It’s all about finding the right level of risk that is appropriate for you and your circumstances, changing only when your circumstances change. Shares typically give you a higher return over the long term, but are riskier. Whereas bonds are more stable but offer lower potential return. 

To determine your appropriate level of risk, you should first understand the following concepts:

• Risk tolerance – this is your willingness to take on risk in your portfolio and how comfortable you are with potential fluctuations within your portfolio. 
• Capacity for loss - this is your ability to withstand any loss in your portfolio. This is determined by your cash flow needs and investment horizon.

Here are three reasons why keeping a balanced and diversified mix of investments can help you to achieve investment success.

Asset mix impacts returns

Whether you're managing your investments on your own, using a ‘do it for you’ service such as our managed ISA or pension, or working with a financial adviser, it's important that the mix of assets in your portfolio aligns with your attitude to risk and fits the returns you need to meet your specific financial goals. 

The graph below shows a simple example of the relationship between shares and bonds to demonstrate the impact on returns.

The first bar (light green) shows a portfolio with 100% bonds and no shares, with an average total return of 5% between a range of 53.1% and -23.2%. The amount of shares increases by 10 percentage points each bar along, while the amount of bonds reduces by 10 percentage points. As you can see, the higher the amount of shares, the higher the average total return while the range of return also tends to expand. 

For example, the final bar (peach) which shows a portfolio with 100% shares and no bonds, has an average total return of 8.7% and a much wider range between 145% and -52.6%. This shows that while shares have the tendency to deliver higher returns than bonds, they can also result in greater losses.

A portfolio’s mix of assets defines its range of returns

Notes: Reflects the maximum and minimum calendar year returns, along with the average annualised return, from 1901-2023, for various share and bond allocations, rebalanced annually. Shares are represented by the DMS UK Equity Total Return Index from 1901 to 1969; thereafter, shares are represented by the MSCI UK Total Return Index. Bond returns are represented by the DMS UK Bond Total Return Index from 1901 to 1985; the FTSE UK Government Index from Jan 1986 to Dec 2000 and the Bloomberg Sterling Aggregate Index thereafter. Returns are in sterling, with income reinvested, to 31 December 2023.

Source: Vanguard

Past performance is not a reliable indicator of future results.

Spreading your investments across different assets, sectors and countries can help to reduce the overall volatility (fluctuations in prices) of a portfolio, while also cushioning against unnecessarily large losses from any one investment.

This is because shares and bonds have historically behaved differently to each other, with shares tending to perform better than bonds in the long run but also tending to be more volatile. Bonds have tended to act as a counterweight to shares, helping to smooth out returns.

Remember, though, that past performance is no guarantee of future returns and there is a risk you may get back less than you invested.

Shares can be risky – but so is avoiding them

Shares have historically been more volatile in the short term (one to five years), meaning they have fluctuated in price more sharply than other investments such as bonds or cash. But they have delivered greater returns over the long-term (10 years or more) and avoiding them brings the risk of not achieving sufficient growth. 

As the graphs below illustrate, cash may be substantially less volatile than shares, but shares have generally outperformed cash. The first graph, which shows the performance of cash and shares between 1901 and 2022, tells us that cash (the yellow line) was substantially less volatile than shares (the green line) over a one-year investment horizon. This is shown in the graph by cash returns hovering more or less around the 0% to 10% mark each year while returns from shares bounced around more erratically each year from as low as -40% to as high as 70%.

However, the second graph, which shows the annualised² performance of cash and shares over 20-year time horizons between 1920 and 2022, shows that despite this volatility, shares have generally outperformed cash – and at times, by wide margins. This graph also emphasises the importance of thinking long-term when it comes to investing.

Though more volatile in the short run, shares have tended to outperform cash in the long run

Notes: Data from Dimson-Marsh-Staunton (DMS) dataset series for 1901–2022. Shares are nominal return (the amount of money generated by an investment before factoring in expenses such as taxes, investment fees, and inflation), and is defined as the DMS Real World Equity Total Return adjusted by DMS World Inflation. Cash is the nominal bill return, defined as the DMS Real World Bill adjusted by DMS World Inflation. Graph 1 represents one-year returns of shares and cash while graph 2 represents rolling 20-year returns (annualised). In graph 2, the end point of the first rolling 20-year period is the first data point.

Sources: Vanguard calculations, using DMS global returns data from Morningstar, Inc. (the DMS World Equity Index and the DMS World Bond Index, in both nominal and real terms).

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

It can be particularly tempting to stay in cash – or to invest less in shares – when you’re feeling nervous about the markets. However, long periods out of the market can increase your chances of underperforming.

This is because it is notoriously difficult to time the markets successfully. If you decide to buy back into shares when the outlook is brighter, the chances are that share prices will have already moved higher and you will have reduced your potential returns by being out of the market.

Manage risk by diversifying 

As we’ve already established, spreading money across different types of investments is a powerful strategy for managing risk and potentially reducing overall volatility. 

Although it can’t insure against losses, it can help guard against unnecessarily large losses. When a portfolio has a mix of many or all key market components (such as different assets, sectors or countries and regions), it means they can enjoy returns from stronger areas while mitigating the impact of weaker performers at any given time.

This is because the overall volatility of the portfolio is reduced, as investors are not “betting” on any one particular investment or type of investment. 

Above all, balance is needed for investors to reach their goals. Building a balanced and diversified asset allocation will help you to manage risk while benefiting from the rewards, and ultimately enable you to achieve better outcomes.

¹ Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest and return the capital at the end of the term.

² Annualised returns show what an investor would earn over a period of time if the annual return was compounded (i.e. the investor earns a return on their return as well as the original capital).

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Important information

Vanguard Asset Management Limited only gives information on products and services and does not give investment advice based on individual circumstances. If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described, please contact your financial adviser.

This article is designed for use by, and is directed only at persons resident in the UK.

The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information does not constitute legal, tax, or investment advice. You must not, therefore, rely on it when making any investment decisions.

Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.

© 2024 Vanguard Asset Management Limited. All rights reserved.