Stock markets in the United States and around the world have seen losses of 20% to 30% or more so far this year. The Federal Reserve Bank has been aggressively raising interest rates and tightening monetary policy, inflation has reached 40-year highs and geopolitical risks are elevated.
Most bond asset classes have performed negatively this year, as well, as interest rates have caused the value of existing bonds to fall. Some good news is that the interest paid on cash and short-term bonds has increased to levels not seen in more than a decade.
How do investors deal with declining balances in their retirement plans and other investments?
First, it is important to be patient and to try to take the emotion out of investing. Also, diversifying your portfolio and re-balancing during times of high market volatility can help investors weather the storm.
Being patient doesn’t mean ignoring your investment portfolio. I believe you should always know where your money is invested and how it’s performing. But you should not always react, especially by selling when you see a drop in the value of your portfolio.
Over the last 15 years, the S&P 500 Index, a common measure of the United States stock market, has had an average annual return in excess of 10%. For three years, the annual performance was negative.
The lowest return during that time period was -37% in 2008 and the highest return was 32.4% in 2013. If an investor was to panic and sell after 2008, it would have resulted in a huge loss. Patience would have allowed the investor to reap the benefits of higher returns in the years following the large loss.
Having all of your portfolio invested in the S&P 500 Index, or any single index for that matter, may not be the best strategy. This is where diversification and re-balancing your portfolio will help.
Diversification involves spreading your investment dollars out over multiple asset classes. Instead of just investing in US stocks, a diversified investment portfolio may include cash, bonds (both US and foreign), international stocks, real estate, commodities and other asset classes.
Investing in bonds has historically added safety to portfolios, although 2022 has been a challenging year, as previously mentioned. Bonds pay interest, so there is a positive return coming back to the portfolio. Bonds also mature at face value so the bondholder is guaranteed by the issuer to receive their original investment back. These factors contribute to the relative safety of bonds and make them a desirable complement to stocks in a portfolio.
Rebalancing your portfolio after significant market volatility will reset the portfolio back to the intended allocation. Usually this involves buying into the asset classes that have performed negatively and selling some of the asset classes that have performed well. This is often referred to as “buying low and selling high.”
Rebalancing a portfolio should be done while considering current market and economic conditions. The proper mix of different asset classes, when actively managed and re-balanced, can add return and reduce risk in an investment portfolio.
While periods of market volatility can be stressful, patience, diversification and rebalancing can be good tactics for the long-term investor.
Chris Walden is a Certified Financial Planner professional and an active member of the Financial Planning Association of Greater Kansas City. He serves as an Investment Advisor with Heartland Capital Advisors, LC, a Registered Investment Advisor in Independence.