Investors have enjoyed spectacular returns for the past two years. In 2019, the S&P 500 returned 31.5% on a total return basis and last year, after a tumultuous downturn in March, market returns topped 18.4%. After two years of double-digit increases, it’s easy to fall into thinking that the market will just keep going up. But history tells us a different story. It’s important to remember that markets can pull back, or correct, at any time. With the markets still posting solid gains, the time to prepare your portfolio for the next downturn is now.
Asset allocation, the percentage of equity or stocks that you own, versus the percentage of fixed income or bonds and cash in your account is an important place to start. Asset allocation is not a one-size-fits-all proposition. There can be several “correct” answers to a proper asset allocation mix and spending the time getting this right will help to keep you on track. A strategy or rule of thumb that financial planners employed in the past was to recommend having your age be the percentage you hold in fixed income or bonds. That way, as you age, your portfolio becomes more stable, and you are unlikely to experience large losses when the market corrects. But that thinking is outdated as interest rates on fixed income investments have plummeted since 2007.
Investors are unable to get the income they need to keep pace with inflation in a very low-interest-rate environment. Additionally, retirees are now living longer and could need their money to last 30 years or more. This might mean holding a greater percentage of your account in equities or mutual funds with a dividend focus. Things to consider when deciding on your asset mix include: your investment time horizon, when you plan to start withdrawing funds, your other sources of income, and your risk tolerance. It can be suitable for an investor of retirement age to have an aggressive asset allocation if they do not plan on drawing on the funds in their lifetime and the portfolio is instead intended for heirs. Likewise, if watching your portfolio experience large fluctuations makes you weak in the knees, it is appropriate to hold a more conservative asset mix.
Over the past two years, equities have far outpaced fixed income, and you may look at your account and see that you now have a greater percentage in equities than you started with. And while gains are a welcome event, this could lead to you having more investments weighted in equities, which increases the risk to the portfolio beyond what was initially intended. And, within the equity portion of your account, you are likely to see that some asset classes significantly outperformed others. Last year was a great year for technology, home improvement, and food retailer stocks. It was a terrible year for airlines, cruise lines and commercial real estate. Now can be an appropriate time to trim back on your outperformers. We know that from year to year the top-performing asset classes can vary wildly and having a diverse portfolio can help to “smooth out” big swings over time. When selling assets to rebalance your portfolio, it is important to consider the tax implications to avoid unpleasant surprises come tax time. This is a good time to review your portfolio with your Wealth team. They can recommend changes to bring the account back into balance while minimizing the tax burden.
How often should an investor rebalance their portfolio? The answer is, it depends. In a tax-deferred account, like an IRA, it may be appropriate to adjust on a quarterly basis. On a taxable account, it is important to consider the tax implications of rebalancing. Significant movements in the market, either up or down, might also be an appropriate time to rebalance.
I like to tell my clients that I am always planning for the worst-case scenario. It’s important to know where you will get your funds from should you need access to money when markets pull back. Cash and liquid investments, those that can readily be turned into cash without incurring losses, are the first place to draw from. The last thing you want is to be forced to sell equities in a down market. It’s wise to look at your budget and determine what level of cash is right for you to cover your day-to-day expenses for the next few months. Market recoveries can come on quickly and without notice, so it’s important to stay invested to enjoy the gains that come with the upswings.
VP, Portfolio Manager
Janice Beyer is a Vice President and Portfolio Manager for TCF Wealth. In addition to managing client portfolios, Janice analyzes the major factors impacting the construction of client portfolios: asset allocation, sector weights, security selection and bond portfolio characteristics. Janice joined TCF in 2009 and has over 27 years of experience in the investment industry. She earned her BSBA from Central Michigan University and holds the Behavioral Financial Advisor BFA™ designation. An avid community volunteer, Janice currently serves as President of the Traverse City Track Club, the largest and oldest running club in Michigan. She is the current Area 2 Director for Zonta International and a member of the Economic Club of Traverse City.
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