It’s been a rough ride for investors this year. A portfolio checkup might be in order
Most successful investors view the opportunity set of stocks, bonds, real estate or other assets with a strategic long-term lens. But in times as we’ve experienced through the first half of 2022, a short-term evaluation might lead to beneficial actions that help keep the long-term view on track.
Broad U.S. stock market indexes, such as the S&P 500, have declined a little over 20 percent, the worst return at the mid-point of the calendar since 1970. The U.S. aggregate bond index is in unprecedented territory with a year-to-date decline of 10 percent. Inflation has reached levels not seen in 40 years. None of these measures define an economic recession, but it is evident that the United States could add this coming reality to the gloom of 2022.
These swift changes, compared to the momentum that the economy and investment markets carried into the start of the year, mean that a mid-year investment review is necessary.
At a high level, first assess the weight of stocks vs. bonds or other assets in your portfolio in comparison to your target. If you started the year with a targeted weight of 60 percent stocks, 40 percent bonds, based on the index returns referenced above, you would have experienced roughly a 16 percent overall decline in portfolio value over the past six months. You would now own closer to 57 percent stocks and 43 percent bonds.
If you re-balance back to your stock market weight, consider adding to international stocks. Vanguard’s Capital Markets Model projects that international stocks might outperform U.S. stocks over the next decade by 2.8 percentage points per year. There is no one path that will play out, of course, but in eight out of 10 of Vanguard’s simulations, the performance edge for international stocks holds. That is partly because, relative to actual company earnings, prices for international stocks are lower than in the United States and also due to higher dividends from foreign stocks.
When evaluating whether to sell existing investments, be sure you are measuring performance in a relevant way. There has been wide disparity this year among different types of stocks. While also posting negative returns, value stocks have outperformed growth stocks by more than 30 percent. If you have a growth stock fund that is down 25 percent, its year-to-date performance might be worse than the broad market index, but it might also have a significant edge over other growth-oriented funds and be worth keeping. Alternatively, if you have a value-focused fund that is down 10 percent, it might appear to be outperforming the broad market index but actually be meaningfully behind its category. Especially when reviewing actively managed funds in your employer retirement plan, IRA or brokerage account, be sure to make a relevant comparison. Morningstar.com is a good source for these details.
If, as part of your evaluation, you determine that your broader financial circumstances, or your comfort taking investment risk, has changed, you might decide that a broader shift in strategy is merited. Make sure, however, that this is a shift to a new long-term plan that is aligned with your goals and preferences, not one trying to navigate around short-term pain with the intent of shifting back when conditions appear to be more positive. The undisciplined approach would likely diminish, rather than improve, returns.
Stocks might continue to decline. Stock prices have shed some excess but don’t broadly appear to be cheap yet. There are many quantitative ways to try to assign a level of value to individual stocks or market indexes. While most measures have retreated from overvalued territory down to fairly valued, many factors (some market/economy-related and some not) could still swing the pendulum of investor sentiment and returns to a lower level before lasting recovery is triggered.
A simple step that allows many investors to maintain comfort with higher allocations to stocks over time is to keep enough money in cash, or short-term bonds, to cover all expected expenses for the next couple of years. That way, knowing your short-term needs are covered, you might be more comfortable allowing stocks to ride through volatile times. This reassessment of your cash needs should be done periodically, regardless of recent market performance.
Finally, evaluate options to reduce your taxes on investments. Re-balancing activities might allow you to sell investments in non-retirement accounts that currently have capital losses. Losses can be used to offset taxable capital gains and some ordinary income, improving your after-tax investment return. For some people, it might also be an opportune time to perform a Roth IRA conversion, moving some current pre-tax money to a Roth. After recent declines, you can now move more shares of investments to the Roth, ideally capturing more gains in the Roth’s tax-free environment when stocks recover.
Gary Brooks is a certified financial planner and the president of BHJ Wealth Advisors, a registered investment adviser in Gig Harbor.
