There are a number of different ways to measure portfolio returns, and there are different reasons why you might choose one calculation over another. With our Smart Portfolios¹, we use something called a time-weighted return (TWR). It’s a standard industry calculation that essentially measures the return on your investments, and removes considerations of any additions or subtractions of capital.

Time-weighted return defined

Time-weighted return is a commonly-used calculation when someone else is managing your portfolio for you, because it removes the impact of any deposits or withdrawals that you may make, but which they cannot control. For example, Stash cannot control when you deposit money into, or withdraw money, your Smart Portfolio. 

Although it may sound complicated, TWR really measures how well Stash is managing your money, and how your Smart Portfolio is performing.¹ Returns calculated using other methodologies, which can include your deposits or withdrawals, easily become distorted, and can give you an inaccurate picture of your portfolio’s performance.

For example, another calculation called a simple return takes into consideration the timing of your cash flow into or out of your portfolio, and it measures the actual dollar amount earned on your portfolio, indicating the change in the total investment value. This is a factual calculation, but it may not properly reflect the portfolio manager’s investment strategy.

Time-weighted return in action

Take a look at the following example, where we have two fictional investors who deposit money in different months, into the same hypothetical portfolio. The impact of the cash flow is removed from the weighted return calculation, so the monthly time-weighted return experience is the same regardless of whether someone deposited money.

*Remember all investors are different, and you must take into account your own financial situation and goals when investing.  All investing involves risk, and it’s possible to lose money in the market. The Hypothetical below is purely for illustrative purposes and does not represent the actual performance of any client nor does it reflect the performance of any of the underlying investments therin.

This hypothetical does not account for fees or taxes. It is for illustrative purposes only and is not indicative of any actual investment. Actual return and principal value may be more or less than the original investment. Investing Involves Risk, including the loss of principal. 

Positive time-weighted return and negative dollar value

Investor A and Investor B both start out by investing $100 in the portfolio, which has a +20% return in January, followed by a -10% return, or loss, in February. 

In January, Investor B makes a $100 deposit into the account right before the market upswing, while Investor A does not. Since Investor A’s holdings are smaller, his or her gain would be $20  in January. In comparison, Investor B invests more money, and gains $40 that month. 

In February, let’s say Investor A makes a $100 deposit into the account, while Investor B does not. The opposite happens here: Investor A buys right before the market dips, resulting in a $22 loss, and a $24 dollar loss for Investor B. 

While both investors have an 8% gain for the two months, Investor A loses $2, while Investor B makes $16. That’s because Investor A contributes to the market right before a market dip, while Investor B contributes right before the upswing. Investor A’s poor timing has an impact on the actual dollars earned (or lost in this example), while the portfolio’s investments actually have a positive return during the same time period. 

Our investing philosophy

We recommend following the principles of the Stash Way when you’re investing: Think long-term, invest regularly, and diversify. By investing regularly, investors will sometimes put money into the market when prices are higher, and at other times when they’re lower. Over time, you’re likely to get a better price-buying experience.

Remember though, all investing involves risk, and you can always lose money in the market.

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The lesson is obvious in the real world—you don’t want all of your eggs to break if you drop the basket. But what does it actually mean when it comes to putting money in the market? 

It’s really about the importance of diversification, which is one of the core principles of building a first portfolio. Diversification is also part of the Stash Way, our financial philosophy, which also includes long-term investing and regular investing. 

Let’s take a deeper dive into diversification, and we’ll show you why it matters. 

Diversification defined

Diversification simply means using your money to invest in many different types of holdings that are not all subject to the same market risks, including stocks, bonds, and cash, as well as mutual funds and exchange-traded funds (ETFs). By diversifying, you can choose investments in numerous economic sectors—not just the hot industry of the moment—as well as in different geographies around the globe. 

This is an important concept because diversifying can reduce market risk (volatility) that may subject you to potentially lose a significant amount of money unexpectedly. Keep in mind that volatility exists when it comes to investing and you want to try to navigate your experience as you make progress to accomplish your investment goals.

Let’s take a look at this hypothetical scenario comparing two investors who have constructed their portfolios in different ways, to see diversification in action. We will examine how each of these investors’ portfolios would have performed over the last 20 years. 

*Remember all investors are different, and you must take into account your own financial situation and goals when investing.  All investing involves risk, and it’s possible to lose money in the market. The Hypothetical below is purely for illustrative purposes and does not represent the actual performance of any client nor does it reflect the performance of any of the underlying investments therein.

There’s a big difference between the two portfolios, where one investor is more diversified than the other. For example, Investor A has a diversified portfolio that is invested in different asset classes, including stocks and bonds.  Likewise, Investor A has invested globally, not just in the U.S., but in developed countries internationally (think of countries including the United Kingdom and Japan), and emerging markets with developing economies, such as India or China. 

Meanwhile, Investor B has concentrated investments in the largest companies in the U.S. 

You might think that since Investor B has 100% of his portfolio in stocks and Investor A has 20% in bonds, that Investor B’s portfolio performance would probably beat Investor A’s. However, that may not be the case.

The following chart, which examines what would happen if $1000 was invested in each portfolio over the last 20 years, shows why.

Source: Stash, FactSet as of 12/31/2000-12/31/2020. A diversified portfolio is represented by 45% Dow Jones US Total Stock Market, 20% MSCI EAFE Index, 15% MSCI Emerging Markets Index, 20% Bloomberg Barclays US Universal Index. Assumes portfolio is rebalanced annually. The grey shaded areas represent historical periods where there was market volatility. Past performance is not indicative of future results. You cannot invest directly in the index. This hypothetical does not account for fees or taxes. It is for illustrative purposes only and is not indicative of any actual investment. Actual return and principal value may be more or less than the original investment.

Investor A would have actually beat Investor B’s performance, while meaningfully reducing the overall volatility, or risk, in the portfolio. Why? The answer is diversification.

Many investors have the misconception that if you start adding relatively safer investments like bonds, which traditionally have lower returns than stocks, that your performance wouldn’t be as good.

But that may not be the case. That’s because stocks and bonds have almost an inverse relationship to one another.  That means if stocks prices go up, bond prices tend to rise, and vice versa. Bonds can also be typically safer than stocks and can provide an anchor to your portfolio when there is volatility in the portfolio. When stocks plummet, bonds tend to remain steady. We’ve seen this through various financial crises, and most recently during the 2020 pandemic. 

Although many investors tend to invest in U.S. companies, because it’s one of the strongest economies in the world, a properly diversified portfolio can also include investments that give you exposure to other areas in the world. Not all countries have the same economic conditions and circumstances, and when there’s an economic crisis, some may even recover faster than others. Additionally, some countries in up and coming markets have greater gross domestic product (GDP) growth potential compared to the U.S. You may want to have exposure to that growth.

Let’s drill down a bit further, taking a look at significant market events over the last couple of decades to see how each of the portfolios would’ve performed.

Source: Stash, FactSet as of 12/31/1999-12/31/2020. A diversified portfolio is represented by 45% Dow Jones US Total Stock Market, 20% MSCI EAFE Index, 15% MSCI Emerging Markets Index, 20% Bloomberg Barclays US Universal Index. Assumes portfolio is rebalanced annually. “Dotcom Bubble” is represented as the period between 12/31/1999-9/30/2002, “Recovery from Dotcom Bubble” is represented as the period between 10/1/2002-9/12/2008, “Financial Crisis/ Great Recession” is represented as the period between 9/13/2008-3/9/2009,  “10+ Year Bull Market” is represented as the period between 3/10/2009- 2/21/2020, “Covid-19 Outbreak in the US” is represented as the period between 2/22/2020- 3/23/2020, and “Recovery from Pandemic” is represented as the period between 3/24/2020- 12/31/2020. Past performance is not indicative of future results. You cannot invest directly in the index.

Although it may not feel like it at the time, diversification can help reduce volatility and the risk of losing money, and may even help a portfolio perform better than a non-diversified portfolio over the long run.

In each time period, with the exception of the recoveries from the 2008 financial crisis and the 2020 pandemic, you can see Investor A’s diversified portfolio actually outperformed Investor B’s, with its concentrated investment in the U.S. stock market. In fact, Investor A’s annualized volatility, which is a measure that shows how risky an investment is, was meaningfully lower than Investor B’s regardless of time period. (12% vs. 20%.) Simply put, Investor A was able to achieve better results, while taking on considerably less risk. 

Holding a diversified portfolio does not mean that you can’t lose money. Notice that Investor A still lost money when the Dotcom bubble at the end of the 1990s, as well as during the 2009 financial crisis, and Covid-19 pandemic beginning in 2020.  However, Investor A lost less money than Investor B during those times, because Investor A was diversified. 

Diversification can help your portfolio weather moments of short-term volatility. 

In times when the market is doing well, such as during the last bull market or in the ongoing recovery from the pandemic, it may seem like you’re not making as much money. Shifting your focus to the long-term, having a steady diversified portfolio can help you end up making more than a less diversified portfolio meanwhile exposing you to less risk than a concentrated portfolio. The lesson? Risk reduction does not necessarily have to come at the expense of reduced performance. 

That’s why Stash always reminds you to think of the long term, and stick to a portfolio that is representative of your investment goals. Let that drive your investment decisions, not emotions. Diversification, investing for the long term, and investing regularly are all part of the Stash Way, our investing philosophy.

Bottom line: although it may not feel like it, diversification can work through times of volatility and even in up markets. Diversification is one of the investing principles of the Stash Way. We want to constantly remind you to diversify so you are building good investing habits. Note: It’s important to remember that even with diversification all investing entails risk, and you can always lose money in the markets.

Consider a Smart Portfolio

Here at Stash, we have two ways to help you do this. 

If you are new to investing or you would like to be more hands-off with investing, we created Smart Portfolios. Our team of investment professionals created portfolios consisting of exchange traded funds (ETFs) that are diversified to minimize risk to help you obtain investment goals. You don’t need to monitor or make any investment decisions, because we do this for you.¹ 

If you rather be more hands-on with your portfolio, we’ve created the diversification analysis tool.² The tool will take a look at your portfolio and align it towards your risk profile to make recommendations and create guardrails that steer you back on track towards your goals. Diversification analysis only works with Personal Portfolio³ accounts, where you make the investment choices for the stocks, bonds, and ETFs you want in your portfolio.

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A diversified portfolio will hold a variety of investments that are not all subject to the same market risks, including stocks, bonds, and cash, as well as ETFs. It’s also important to invest in different markets globally, not just in the United States.

With that in mind, Stash is excited to launch something called Smart Portfolios, a new type of account that can help take the guesswork out of building a diversified portfolio. Here’s how it works. A Smart Portfolio¹ is a personalized portfolio that Stash’s Investment Team of financial experts has created for you based on your risk profile. Stash actively monitors and manages the account for you, and rebalances when necessary. (We’ll explain more about rebalancing later.) All you have to do is put money—a minimum of $5— into the account, and Stash does the rest.

What’s a risk profile?

When you signed up for Stash, we asked you a few questions about your investment style, and financial circumstances. We used this information to place you into one of three risk profiles–conservative, moderate, and aggressive. The information you provided also helps us calculate your risk tolerance and investment time horizon. 

Here’s what that means:

• Conservative risk profile investors prefer stability, even if that means smaller gains—but may still want some growth potential for their portfolio. These investors might have more bonds in their portfolios than aggressive or even moderate investors. They may need their money sooner rather than later and cannot endure additional risks.
• Moderate risk profile investors are looking to build stable portfolios, but may also have the capacity to take on a little more risk in exchange for potentially higher long-term growth. Their portfolios might be balanced between bonds and equities, or stocks.
• Aggressive risk profile investors may be looking to maximize the long-term growth potential of their portfolio, even if that means sacrificing some stability and incurring greater risk.These investors have the ability to own more stocks in their portfolios than bonds. They probably will not need their money for a while, meaning they have a longer time horizon.

We’ll use these risk profiles to create a diversified mix of exchange-traded funds (ETFs) for you, calculating the correct allocation based investing risk level, which can act as guardrails for your investing.

What’s in a Smart Portfolio?

Stash’s Investment Team believes that a well-diversified portfolio should consist of a mix of stocks and bonds. Within stocks, you can invest in different regions such as the U.S., developed economies such as Western Europe, and emerging markets like China. Similarly, you can invest in different types of bonds, such as corporate bonds, which are issued by companies, or U.S. Treasuries, issued by the federal government. You want to consider spreading your investments across various asset types, because different assets will respond differently to different market conditions, potentially reducing volatility in your portfolio.

With that in mind, the Investment Team has picked the following ETFs, with low expense ratios, that represent each of these categories.

The funds represent a diversified group of stocks in the U.S. and internationally, as well as bonds. While the three risk profiles will be invested in the same funds, how much money goes into each fund will vary based on the allocation that was initially recommended for you.

Here’s what that means. Let’s say you are assigned to the aggressive risk profile. Our Smart Portfolios may place a greater percentage of your money in stocks versus bonds. Whereas if you have a conservative risk profile, a greater percentage of your money might be placed in bonds. Stash’s Investment Team will help make sure your portfolio stays diversified according to your risk profile as your investments grow and as markets change.

Smart Portfolios and the Stash Way

Smart Portfolios also align with the Stash Way, our investing philosophy, which includes investing regularly, thinking long term, and diversification. With Smart Portfolios, you can invest regularly without having to make decisions about where your money should go. Smart Portfolios can also free you from the worry of short-term volatility by making sure you stick to your long-term financial goals.

Diversification and rebalancing

From time to time, we will rebalance your Smart Portfolio. Rebalancing can help you stay properly diversified, and it can ensure you are exposed to the appropriate amount of risk.

Stash designed each Smart Portfolio with a different target allocation of investment categories based on an investor’s risk profile. Based on how the underlying investments move over time, it’s possible an investor’s actual portfolio allocation may drift away from its target. In that case, the portfolio may need to be rebalanced by selling some investments that are overweight and buying others that are underweight in order to get back on track.

Here’s a hypothetical example. Let’s say that based on an investor’s risk profile, his or her portfolio has a target of 80% stocks and 20% bonds. For example, let’s say you invest $100 in this portfolio—$80 in stocks and $20 in bonds. Now imagine that the stock market declines, but bond prices go up. As a result, the investor’s portfolio would look a little different. Maybe the investor’s stock portion shrinks to 75% and the bond portion grows to 25%. In other words, you’d have $75 in stocks, and $25 in bonds. The investor’s portfolio has “drifted away” from its target. In order to get it back on track, the portfolio would need to be rebalanced. By selling some of the bond position and buying more stocks, the investor’s portfolio can be reset to the target allocation.In this case, the portfolio would sell $5 worth of bonds and purchase $5 of stocks to get back on track. 

The good news is that Smart Portfolios automatically rebalance. Stash takes care of all of the hard-work. Stash sets the targets and regularly monitors market moves. If a Smart Portfolio account drifts too far away from its target goal, Stash will automatically sell some of the positions that have grown too fast and buy more of the positions that may have decreased in value. Rebalancing will occur when a portfolio increases or decreases by 5% or more from its target in a quarter. Stash will reset all portfolios by rebalancing at the end of the year.

Dividend reinvestment

Stash believes in investing regularly in order to increase your growth potential. Reinvesting dividends is an easy way to do this. Instead of receiving dividends in cash, we will reinvest in additional shares of your Smart Portfolio investments.

Withdrawals and deposits

Stash will automatically invest your deposits in your Smart Portfolio. Your deposits will be invested in securities that are underweight, or have decreased in value, in an effort to bring you closer to the target allocation appropriate for your risk profile. Similarly, if you need to withdraw money, Stash will manage this in an efficient way, trimming your overweight positions to raise cash. 

With market movement, the weight of your portfolio holdings will deviate over time. The way we deposit and withdraw your money within your investments allows us to “buy low and sell high,” and presents us with the opportunity to realign your portfolio to the appropriate risk outside of a rebalance period.

More about Smart Portfolio Investing

Any customer who subscribes to the Stash Growth and Stash+ tiers is eligible for a Smart Portfolio account. It is included in your growth and premium tier subscriptions. There are no additional subscription fees. Customers may add or withdraw money to and from their Smart Portfolio accounts to and from their external bank account, but they will not be able to trade individual stocks from these accounts. 

Good to know: All investing involves risk, and you can lose money on your investments. While no one can predict the future, diversifying your portfolio with Smart Portfolio can help protect you against the uncertainty of the market, and can help you reduce your risk. Smart Portfolio investing is a resource for you to help achieve your financial goals.

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