With the S&P 500 hovering 9% below its early January high, financial advisors are reviewing client portfolios to be sure allocations remain within corridors determined by financial plans. The Russian attack on Ukraine caused additional volatility in markets, with stocks declining sharply before rallying back to finish the week with a gain. However, despite the prominence of this event, plenty of other catalysts routinely cause markets to rally and reverse, year-in and year-out.
That’s why advisors regularly check portfolios to verify that the investment mix is aligned with client goals. For example, say the plan for a 60-year-old woman has determined that she can retire in seven years, assuming she maintains a portfolio of 60% stocks and 40% bonds, with market cap and regional assets included with those broad allocations.
In this hypothetical case, the investor’s financial planner included a 20% allocation into large-cap U.S. stocks. As the S&P 500 rallied nearly 27% last year, her portfolio may have skewed heavily toward that large domestic holding, especially as bonds declined. The iShares Core US Aggregate Bond ETF (AGG) and Vanguard Total Bond Market ETF (BND), both common portfolio holdings, were down nearly 2% last year.
So far in 2022, bonds are declining again, simultaneous with the stock market. What does that mean for portfolio allocations?
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More Traditional Stocks
Faron Daugs, wealth advisor, founder and CEO of Harrison Wallace Financial Group in Libertyville, Illinois, says recent market volatility caused his firm to revisit portfolios and actively rebalance.
“We are adjusting from the higher volatility and trendy types of stocks, such as high-tech, and moving into those areas that are considered a little more traditional,” he says. “These more traditional stocks typically pay a solid dividend and may have more pricing power to pass on the increased cost of production onto their final product.”
Companies with that kind of pricing power, he says, are good choices for shareholders. Daugs says examples of more traditional stocks include those hailing from the energy, financial, consumer staples, industrials and materials sectors. He notes that commodities and real estate also provide an opportunity for investors to further diversify into areas that many may have overlooked.
Ryan Johnson, director of portfolio management and research at Buckingham Advisors in Dayton, Ohio, says his firm doesn’t trim stock positions overall when the S&P 500 is 10% off its highs.
“But we still make changes in our custom portfolio reviews,” he says.
Rebalancing Within Broad Asset Classes
For example, if a client has 75% stocks at the time of the firm’s regular review, Johnson and his colleagues may keep the equity stake at 75% while changing the particular securities within that allocation. Johnson emphasizes that despite high day-to-day volatility, his firm’s investment decisions continue to be made with a long-term focus.
“Clients that need another round of buying stocks are higher on our priority list at the moment,” he says.
Advisors don’t panic when they see market volatility, although they may be on the receiving end of calls from panicked clients. That’s where the coaching element of their job comes into play. For example, in addition to keeping clients informed of the reasoning behind allocations, advisors must anticipate future volatility. That doesn’t mean making changes for their own sake. Instead, it means regularly monitoring client accounts to be sure allocations are within designated corridors, whether the market is rallying, trading sideways or declining.
“Optimally, we work to rebalance portfolios in advance of market volatility so they are well positioned when volatility strikes,” says Bryan Shipley, co-CEO and chief investment officer at Arnerich Massena in Portland, Oregon.
“Trying to rebalance while the market is experiencing rapid and unpredictable shifts is likely to backfire,” he adds. “You never know when a bad day in the market will be followed by a quick upswing or vice versa.”
Rebalancing in Any Market Cycle
Shipley points out that his firm balances portfolios on a regular basis, rather than simply reacting to volatility.
“During the last few years, it may have seemed counterintuitive to rebalance during such a strong market, but having discipline meant that we were ready when volatility arrived,” he says.
These days, with elevated volatility in the stock market, along with headwinds in the bond market, Arnerich Massena is emphasizing hedged strategies and alternatives, as well as seeking growth with global equity diversification.
“We have shifted away from traditional bond positions, as they are likely to decline in value with rising interest rates,” Shipley says.
Daugs, too, notes the potential effects of rising rates on client portfolios.
Environment of Higher Inflation
While high-growth sectors, such as technology, have provided investors with lucrative opportunities in the past few years, the new environment of higher inflation, increasing interest rates and geopolitical risk mean that some are now uncomfortable taking on more investment risk.
“These are the times to truly revisit their ‘risk budget’ and rebalance as needed,” Daugs says. He cautions against looking to fixed income as a way of mitigating downside risk. “Bonds and bond funds tend to be incredibly volatile in anticipation of increasing interest rates. Because of this, they are not as effective in reducing downside and purchasing power risk, as we do not want to lock clients into the currently low yields.”
Because bond prices will become compressed as the Federal Reserve increases interest rates, Daugs says investors would be better served with higher-yielding sectors such as real estate, industrials or energy.
“These more traditional, less flashy sectors may not be as prone to wild swings in the new environment,” he says.
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Does Current Market Volatility Mean It’s Time to Rebalance Your Portfolio? originally appeared on usnews.com
