“The stock market came back a long way in 2023 and so far in 2024,” says Rob Haworth, senior investment strategy director at U.S. Bank. “Given what has transpired since 2022’s bear market, investors should review their portfolios and determine if it’s still appropriately allocated among major asset classes.”
Strategic portfolio positioning
The primary driver of an investor’s asset mix should be long-term, strategic positions designed to be held over time to meet specific investment objectives. U.S. Bank considers the following to be core components of most well-diversified portfolio:
- Equities. Over the long run, stocks have generated strong returns, driving the majority of portfolio gains over most business cycles. While stocks can be volatile and cause portfolio declines from time to time, they remain crucial return-drivers that can help meet many investors’ long-term goals. Strong consumer spending, corporate earnings growth, and fiscal stimulus post-COVID has helped support the U.S. economy and equity market performance.
- Fixed income. Over time, high quality bonds provide important portfolio diversification and stable current income. These two features make bonds a key component of diversified portfolios. Bonds provide portfolio diversification due to often having an inverse price relationship with stocks. While stock and bond prices don’t always move in opposite directions, they do act differently over time, and provide investors opportunities to rebalance into stocks after a stock market correction. “Investors trying to preserve a conservative portfolio profile can take a little less risk and invest in fixed income instruments today generating yields in the 5% range,” says Haworth. That’s significantly higher than yields were prior to 2022, as higher inflation drove the Federal Reserve to raise interest rates, in turn driving bond yields higher.
- Real assets. Real assets represent investments such as real estate, global infrastructure, and commodities and can help balance a portfolio predominantly made up of stocks and bonds. Some real asset categories provide important income and performance diversification during times of elevated or rising inflation.
Situational strategies
The market environment can also create specific opportunities or ways to help you position assets in a more effective way for a shorter period of time. Here are three situational approaches to consider in the current market environment:
Tactical asset allocation
There may be opportunities to make minor yet important adjustments to the broader, long-term positions represented in your portfolio. However, investors should pursue such short-term tactical moves with prudence. “Specific tactical moves designed to capture a market opportunity within any of those asset classes require investors to be nimble and willing to move quickly in and out of specific positions,” says Haworth.
For example, in today’s environment:
- Large U.S. stocks: Equity investors may want to consider a modest tilt toward stocks over bonds. Since a standard index fund features overweight positions in the largest stocks that have already earned outsized returns, investors should consider a fund that offers equal-weight exposure to large U.S. stocks. The largest corporations are less interest-rate sensitive, as many extended debt maturities and locked in low interest rates for longer terms prior to the Fed’s interest rate policy change. These companies also tend to have large cash balances, which are currently earning more than 5% interest.
- Commodities: Offer more consistent inflation sensitivity, even if economic growth slows, based on historical analysis. In the current environment with inflation remaining stickier than many anticipated, commodities can provide unique portfolio benefits.
- Treasury Inflation Protected Securities (TIPS): Inflation-sensitivity can be addressed with a position in TIPS. These government-backed bonds historically offer less protection against high inflation than commodities, but feature less portfolio volatility, making them appropriate for more conservative portfolios.
- Residential mortgage bonds: Non-taxable fixed-income investors may want to consider residential mortgage-backed securities that are not backed by the government, which have strong fundamentals and offer competitive current income. These securities are particularly attractive given low mortgage loan balances relative to home values and strong incentives for homeowners to remain current on low fixed rate mortgages they locked in prior to the onset of higher interest rates.
- Municipal bonds: Tax-aware investors can earn extra potential returns by slightly extending maturity profiles in municipal bond holdings and incorporating a modest allocation to high-yield municipal bonds. While these are on the riskier end of the tax-free bond spectrum, Haworth says credit quality is holding up well in today’s economy and defaults remain low.
- Insurance-linked securities: Tied to the sale of reinsurance products, these securities can offer highly competitive income streams in the current environment for certain types of investors, particularly within trust portfolios.
Dollar-cost averaging
Investors can accumulate cash in their portfolios through interest, dividends, or through security or business sales proceeds. Investing cash into higher returning asset classes such as equities is key to meeting long-term financial goals. However, markets may still exhibit volatility from time-to-time, which can affect investors’ willingness to put lump sums to work in assets subject to fluctuation such as stocks.
Dollar-cost averaging is a strategy that may increase your comfort level with equity investing during volatile times. This involves investing a portion of your cash balance into the target equity portfolio through regular intervals rather than trying to invest the cash all at once (a practice called lump-sum investing).
“Dollar-cost averaging is a way to get money invested without experiencing the regret that would occur if markets decline immediately after investing a lump sum,” says Haworth. “It elongates your investment period, so you don’t start at just one price point in the market.”
Regularly directing assets from cash into the target portfolio of equities and other holdings, for a period of six months to two years, may reduce the risk of a large portfolio setback in a brief period of time. “It’s an effective and efficient way to invest so you participate when the market environment is favorable,” says Haworth.
Rebalancing
Investors may wish to consider rebalancing their portfolios, depending on their investment objectives. Asset prices can move in different directions and at different speeds, and these return variations can cause your initial portfolio allocations to drift from your long-term strategy.
Fixed income portfolios may require attention if investors emphasized high-yielding, short-term debt securities up to now. “Prior to 2023, investors were dealing with interest rates that were still rising, a riskier environment for long-term bond investments,” says Haworth. “We appear to be at a point where short-term interest rates are near a peak. This may be a time for investors to direct cash-oriented investments into other long-term assets.”