20 ideas for adjusting your stock and bond portfolio
17 min read
12 Aug 2022, 01:25 AM IST
Stocks are down, inflation is high and a recession may be looming. We asked financial experts what investors should do
PremiumIs it time to rethink the percentage of stocks you hold in your portfolio? The standard ratio is often 60% stocks and 40% bonds. Of course, that varies depending partly on an investor’s age or risk tolerance. But with stocks down, inflation rising and a possible recession being declared, some experts say the conventional wisdom might need adjusting.
We asked experts for their thoughts. Even the ones who say the percentage shouldn’t necessarily change say investors would do well to make some adjustments.
Here is their advice:
Consider a 50/50 blend
Inflation and Federal Reserve interest-rate increases will be challenging for stocks over the next six to 12 months, so I think anyone with that time horizon should consider reducing stock exposure relative to cash, bonds and commodities.
Why cut exposure when stocks are down about 10% so far this year? Company earnings are coming back to earth from highs last year, but estimates remain optimistic. If we assume a shallow earnings recession (earnings slip but broad economic growth remains OK), the S&P 500 looks approximately 20% overvalued on our models.
If I’m right, investors will likely see a typical recession scenario: Stocks down and bonds up.In that case, consider reducing a typical 60/40 stock/bond blend now to 50/50 and then moving back to 60/40 after a further selloff. Bear in mind that even if you time the exit from stocks correctly, increasing your equity allocation can be tough when the market is gripped by risk aversion. Nonetheless, it often is the exact right time to do so.
Nanette Abuhoff Jacobson, global investment strategist, Hartford Funds, Boston
The volatility factor
Most working-age people’s biggest economic asset is not their already-accumulated savings, but their future wages. Wage growth has low correlation with stock returns, so future wages represent a huge implicit fixed-income holding. That means that most people should hold close to 100% of the money they don’t need to cover regular monthly expenses in stocks.
A wrinkle to the above advice is that when stock-market volatility is extremely high, as it has been, it can make sense to temporarily scale back one’s stock positions. That’s because the market’s average return doesn’t increase when volatility is high, so the market is a relatively bad deal during those times.
When the VIX (the market’s forecast of the S&P 500’s volatility over the next month) rises above 30, I start thinking about modestly reducing my stock exposure. In the early summer, I scaled back my stock positions by 5 percentage points. When the VIX hit its all-time high of 83 in March 2020, I reduced my stockholdings by 80 percentage points. But be aware that high-volatility episodes are usually short-lived, so if you do sell stocks in response to a volatility spike, you need to be attentive and ready to come back into the market quickly as soon as volatility has calmed down.
James Choi, professor of finance at Yale School of Management in New Haven, Conn.
The rule of 120
For many years, I’ve subscribed to the rule of 120 to keep it simple when it comes to asset allocation. And in this volatile period, it’s no different. In the rule of 120, you subtract your age from 120 and it will tell you how much money should be in equities and how much money should be in fixed-income assets such as bonds. Thus, a 50-year-old would have about 70% (120-50) in equities and the remaining 30% in fixed-income assets. With this model, as you get older your overall risk level gets dialed down modestly annually.
And when it comes to the equity portion in this time of inflation, shrinkflation and possible recession, the real question should be, “Are you owning the right types of stocks?" rather than, “How should you change the allocation of overall stock percentages?" Now would be the appropriate time to add dividend-paying, value-based stocks instead of the high-growth technology companies investors have been chasing over the past 10 years. These include consumer staples, healthcare, financials and utilities.
Ted Jenkin, co-CEO and founder of oXYGen Financial in Atlanta
Focus on the future, not the past
Absent a material change in an investor’s financial objectives or circumstances, significantly reducing your equity exposure may not be the right move. The markets care less about whether things are good or bad, and more about whether they are getting better or getting worse. While the getting worse phase might persist for a little longer, the markets should begin to factor in improving conditions during the second half of the year. That means what’s worked over the past 12 months may not work over the next 12.
With that in mind, there are two moves investors can make to reposition themselves for the next leg of the market cycle:
Seek the diamonds in the rough. Among the carnage in the tech sector, there are some great businesses that now offer more attractive entry points.
Gradually add back risk. We often consider a “half-back" approach. For example, if a client’s strategic allocation to equities is 60% and the market has moved them to 50%, they should consider increasing stocks to 55% as a first step.
Brian Presti, director of portfolio strategy, the Colony Group in Concord, N.H.
Don’t lock in losses
While it’s tempting to reduce your allocation to stocks right now, it’s worth noting that half of the S&P 500’s best days in the past 20 years occurred during a bear market. Another 34% of the market’s best days took place in the first two months of a bull market. Missing those best days is far more harmful to your long-term wealth than staying the course through the current market environment.
Being a long-term investor means accepting the inevitable periods of negative returns. Uncertainty and temporary losses is the cost you must bear in exchange for the higher expected returns stocks provide. By reducing your stock exposure now, you are effectively paying for the cost of higher expected returns (by locking in losses) without sticking around to earn the higher long-term returns that attract investors in the first place.
In fact, the only adjustment that might be worthwhile is increasing your stock exposure—but only if your financial plan supports it. If you’re retired and your financial plan strongly suggests you will leave assets to heirs, consider increasing the stock exposure to more closely align the risk profile of the portfolio with those who will eventually inherit it. For investors still in their working years, if the current downturn hasn’t bothered you and you have the stomach for additional potential losses, then perhaps your risk tolerance is actually higher than you initially thought and you could increase your stock exposure and benefit from buying low.
Peter Lazaroff, chief investment officer at Plancorp, St. Louis
Rebalance within equities
Investment opportunities exist by rebalancing the risk exposures within your equity portfolio. Though the market is down broadly, we have seen meaningful disparities between specific stocks, styles and sectors. For example, technology and growth stocks have underperformed the broader market, with each lagging behind the S&P 500 by 4 to 6 percentage points. As a part of this rebalancing, investors can realize losses while maintaining market exposure. Lowering current or future tax bills while embracing your long-term investment plan is an easy win through a challenging market cycle.
Jeremy Gonsalves, national director of portfolio management, BNY Mellon Wealth Management in Boston
Look for earnings resilience
Equities were recently trading near their 40-year average price/earnings ratio, having fallen since the beginning of the year. That means investors are no longer paying a premium for most equities. Because of the slowing macro economy, investors should scrutinize the earnings trajectory of companies and start to allocate capital to companies with strong earnings resilience.
Healthcare and staples companies are known for their resilience, and there are plenty of high-quality names in those sectors. There also are resilient companies in sectors with natural organic growth opportunities that will buffer their earnings through this economic slowdown, such as select consumer discretionary companies. Additionally, we see a lot of value in small-capitalization stocks, so 15% to 25% of equity allocation to small-caps may be appropriate given the value that they offer.
Jennifer Foster, executive vice president, co-chief investment officer & portfolio manager – equities at Chilton Trust, New York
Retirees, buy more bonds
Many investors have seen their bondholdings plummet in value as the Federal Reserve raises interest rates. Still, conservative investors, and particularly retirees, should consider buying more bonds. Bond yields and prices have an inverse relationship; as one goes up the other will fall and vice versa. That means it may be a good time to buy more bonds because prices are lower and yields are higher; Treasury, investment-grade corporate and municipal bonds now offer an attractive yield, as well as possible price appreciation due to the eventual bond-market rebound. And with the Federal Reserve raising rates, new bonds that come to market offer more attractive yields as well.
Jonathan I. Shenkman, president of Shenkman Wealth Management in New York
Stick to periodic rebalancing
For most investors, periodic portfolio rebalancing is all that is needed. If your allocation toward stocks at the beginning of the year was appropriate for your goals and time horizon, that shouldn’t change just because of a market correction or bear market. If you were 20 years from retirement at the beginning of the year when the stock market was hitting a record high, you’re 19½ years from retirement now, regardless of whether the market has gone up or down in the months since.
For younger investors, the adjustment to avoid is dialing down stock exposure. A bear market and possible recession represents a buying opportunity for those who can enjoy decades of compounded growth. Even those approaching retirement should be careful about dialing back their risk exposure too much in the face of current volatility. While you should have the first few years’ worth of withdrawals in safer, conservative investments, you don’t want a knee-jerk reaction that locks in losses on money you still may not touch for a decade or more. That removes any hope of those assets rebounding.
Greg McBride, chief financial analyst at Bankrate.com in Palm Beach Gardens, Fla.
A new ‘flight to quality’
Given the recent declines in the stock market on recession fears, it is inevitable for investors to consider reducing the percentage of equities they hold in their portfolios and moving money into what they believe are safer assets—such as gold, U.S. Treasurys or bonds. However, it is difficult to completely sell all the stocks that you hold given the need to diversify the risk of your portfolio. So investors are faced a choice as to which stocks to hold and exit.
My advice is to pursue a flight-to-quality strategy—that is, to choose stocks that are likely to exhibit lower volatility and perform better compared with the broad equity market. This is where a focus on ESG (environmental, social and governance), especially good governance, becomes very handy.
Based on the research I have conducted, the candidates I suggest are the companies engaging in meaningful ESG initiatives that are material to their business and their industries. Such sector-relevance in ESG investments—for example, a chemical company that meaningfully reduces wastewater or an energy company that diversifies into alternative power generation—are more likely to outperform the equity benchmarks. Moreover, shareholder value potential is further enhanced when there are high-ability CEOs, board of directors that are willing to let managers take appropriate risks that can create long-term value, and employees who are bought into the vision provided by their senior leaders.
Aaron Yoon, assistant professor of accounting and information at Northwestern University’s Kellogg School of Management in Evanston, Ill.
Don’t just do something. Sit there.
Selling stocks during volatile market periods may provide comfort in the moment, but it fails to consider the most important question as it relates to a long-term strategy: What’s next?
Our goal is to own high-quality businesses that generate value for investors over time. The best way to do that is to find strong businesses and stick with them through thick and thin. Trying to dance in and out of equities is not a viable long-term strategy. So, adjusting the percentage of stocks in an investment portfolio during a challenging market period is not advisable.
A sound long-term plan isn’t worth the paper it’s printed on if it can’t be sustained during tough times. In order to achieve long-term financial goals over time, investors need a strategic asset allocation that allows them to maintain conviction and to stay invested throughout the market cycle.
Malcolm Butler, CEO at Fiduciary Group in Savannah, Ga.
Seek out dividend-growth stocks
In times like these, the rule of thumb, historically, would be to pile into bonds as a safe haven. The problem is that we also are facing rising interest rates. And higher rates create an inverse reaction with traditional fixed-income market values. We can see this in action considering the iShares Core U.S. Aggregate Bond ETF (AGG) is down about 8% this year. So, bonds are not the typical haven right now. Therefore, it is prudent to be increasing the percentage of stocks in a portfolio—even when confronted with the increased volatility.
In some situations, depending on the investor’s overall risk tolerance, we suggest 60% to 70% equities with the rest in alternative investments such as institutional real estate, private credit and private equity.
To be clear, it is extremely important to be increasing the equity allocation with the right kind of stocks. More specifically, the focus should be on dividend-growth stocks with great fundamentals, balance sheets, earnings, pricing power, etc. Strong dividend payers help the investor wait out the volatility, while still clipping their dividend cash coupons, either for income or to reinvest.
Daniel Milan, managing partner of Cornerstone Financial Services in Southfield, Mich.
Make incremental shifts
The case for adding to the percentage of stocks in a portfolio: If you have excess cash sitting on the sidelines or your portfolio has benefited from this year’s rise in commodities, it may be prudent to scale back the commodity exposure and use the proceeds to add to high-quality, dividend-paying stocks with stable earnings and solid balance sheets. Despite a cautious near-term outlook, market declines provide investors with more profitable opportunities for the long term.
The case for reducing the percentage of stocks in the portfolio: Given the declines in the equity markets, this may be a good time to take advantage of tax-loss harvesting. Investors can lower their cost basis if they reinvest any proceeds back into stocks, or they can use the proceeds to diversify into other areas. Examples may include fixed income now that yields are close to 3% and alternative investments such as structured notes or private debt.
In both cases, incremental shifts of 5% to 10% of the overall portfolio allocation should be considered as well as the investor’s overall risk tolerance.
Ayako Yoshioka, senior portfolio manager at Wealth Enhancement Group in Los Angeles
Get back to your equities target
Both stocks and bonds were down in the first half of the year, but the steeper decline in stocks might have caused the equity portion of portfolios to fall below the intended allocation weight.
For example, a 60/40 stock/bond portfolio at the beginning of the year would have drifted to a 58/42 weight mix by the end of June. Adjusting the stock allocation back to target (if appropriate based on the individual circumstances and risk tolerance) could help investors prepare for the next market upcycle. These deviations from the target allocation could be larger at an asset class or sector level, so trimming overweight investments and reallocating to underrepresented areas could be one strategy to take advantage of the market swings and navigate any continuing volatility.
Angelo Kourkafas, investment strategist at Edward Jones in St. Louis
High-quality IT firms are bargains
The market selloff earlier in the year has reduced some investors’ equity allocations to far below their previously targeted levels. And for investors with a sufficiently long time horizon and risk tolerance, the recent volatility has created an opportunity to increase their exposure to equities to rebalance those portfolios by purchasing stocks at much cheaper valuations.
Generally, we are impressed by the resilience of corporate earnings projections in the face of the myriad challenges to profit margins, which should lead to higher equity returns in the future. More specifically, with earnings multiples in the information-technology sector having dropped precipitously, along with the fact that current analyst consensus is still forecasting double-digit earnings growth for the sector over the next year, there are opportunities to invest in innovative, high-quality tech companies at valuations we have not seen in several years.
Sharon Olson, president of Olson Wealth Group, Bloomington, Minn.
Put cash to work
With inflation still running at more than 40-year highs, investors would be well-served to put their idle cash to work—using the recent selloff to rebalance portfolios to target allocations. Most of our clients hold about 10% cash in their portfolios for opportunities like this.
The S&P 500’s entrance into bear-market territory and the selloff in bonds has left a typical 60/40 portfolio underweight on stocks by about 3 percentage points and overweight on bonds by about 3 percentage points. Adding the full 10% cash to the equities side would restore balance, but retirees seeking income could allocate some of that cash to both stocks and bonds. With yields now near 3% for the 10-year Treasury, investors can add high-quality bonds at attractive prices to bolster their portfolios.
Andrew Crowell, financial adviser and vice chairman of wealth management at D.A. Davidson in Los Angeles
Factor in your company stock
With high inflation and recessionary signals, many investors may feel squeamish about stocks and the associated risk. One stock risk worth noting is the shares you own in your employer and how this holding impacts your overall stock asset allocation. Will your company survive this economic environment? Be sure you’re confident of your assessment and adjust your investment in your company’s employee stock-purchase plan and/or how you manage your restricted stock units (another form of stock-based employee compensation), accordingly. You also need to keep in mind that any adjustments in your company-stock holdings impact your investment portfolio’s overall stock allocation.
Lazetta Rainey Braxton, co-founder and co-CEO of 2050 Wealth Partners, New York
Locking in a fixed return
In my research, I’ve found investors who are especially close to retirement are the most likely to pull out of the market after a decline. While a drop of about 10% in the stock market would normally be a buying opportunity for stocks, I’m not too optimistic about stocks right now given where valuations were before the drop and the significant existing economic uncertainty (i.e., it’s not unreasonable that the stock market could drop another 10% or 20%). So if you’re worried about additional market volatility affecting your retirement savings, it might be time to revisit your portfolio. One investment that will allow you to lock in a relatively attractive rate right now is a fixed-rate annuity, which is also called a multiyear guaranteed annuity (or MYGA). With these products you get a guaranteed return for the product term, typically two to 10 years. Annual yields on a three-year MYGA are above 4% right now, according to Blueprint Income, although rates vary by providers.
David Blanchett, head of retirement research at PGIM in Lexington, Ky.
Align holdings with risk tolerance
Investors should adjust their portfolios to underweight risk relative to their longer-term investment plan. This is most likely accomplished by reducing equity allocations below the percentage set in that long-term plan.
The reason for such an adjustment is that the economic expansion, now in the late stage of its cycle, is quickly progressing to a more likely recession. Stock valuations remain at a premium, which is unusual for an economy where a recession is becoming more of a likelihood. In addition, investors should favor short-duration, investment-grade fixed income for its defensive characteristics and limited sensitivity to further Federal Reserve decisions on interest rates. U.S. small-cap and value stocks appear the most attractively priced traditional equity investments, although they do carry some economic sensitivity. Commercial real estate—both REITs and private investments—appears to be the most attractive risk asset given its low valuation, lower sensitivity to the economic cycles and stronger tie to inflation.
Jason Pride, chief investment officer for private wealth at Glenmede in Philadelphia
What’s your timeline?
Whether or not you should be adjusting the percentage of stock in your portfolio is dependent on how soon the money is needed. Assuming it’s still long term, I recommend that nothing more should be sold. I’m seeing many advisers moving clients into bonds to become more conservative. However, that is not as safe as most people assume.
Stocks and bonds have been in a simultaneous correction for the first time in decades. If you’ve been moving slowly into cash since the beginning of the year, you now have cash to put back into the market when you feel it has hit bottom. If you sell now, however, you create a new problem: deciding when to get back in. Some of my clients already are tiptoeing back into the market, using the cash we created when they sold equities back in January. We won’t get the bottom exactly, but we know in two or three years it should be higher.
Dan Casey, investment adviser and founder of Bridgeriver Advisors, Bloomfield, Hills, Mich.
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