Equities and bonds are supposed to dilute risk

Spreading the risk

When constructing an investment portfolio, its common to have a mixture of riskier assets (usually shares) with other assets designed to offset the risk of those shares (usually bonds/loans).

In his excellent book, Smarter Investing, Tim Hale uses a brilliant analogy to partially explain this “Considerable care is taken in the creation of a blended malt whisky,” Tim writes, “to create a distinctive flavour from a number of single malts that is robust and will remain consistent over time.”

Typically, the riskier part of any portfolio will be comprised of shares using funds which are designed to capture specific proven risk premiums, such as size, value, profitability and investment.

“Whilst some will drink their Scotch neat,” Tim goes on, “others, depending on their palate and their desire to avoid ill effects, will dilute it with water to a flavour and strength that is right for them.”

This is a perfect analogy which illustrates why most investors will “dilute” their portfolios with bonds/loans to create for themselves a more palatable solution.

For the eagle eyed amongst you, the first few months of 2022 was very unusual with both shares and bonds/loans falling in value together.

This has led to some slightly hysterical reporting and commentary suggesting the end of bonds/loans as a portfolio diversifier of “water in your whisky”

In our guest blog, Raj Chana at ebi, addresses the following:

  • Why are bond prices falling?
  • Bonds are supposed to protect you on the downside so why are both equities and bonds falling?
  • How much protection are bonds providing?

Download: Broken Bonds – Why are equities and bonds both falling?

We hope you find the contents informative and reassuring.

If you are concerned about your investments or have any questions, please get in touch or call me on 01825 763366.