Economic uncertainty and political dysfunction such as the U.S. debt-ceiling standoff can have a significant impact on market stability. This can be unsettling, but investors with diversified portfolios and proper asset allocation shouldn't be alarmed. In fact, the potential for more volatile markets can serve as an important reminder to check your allocation and investment strategy to ensure you're still on track. Let's take a look at the investment landscape and consider six steps to help prepare for rough times.
The year to date
The Federal Reserve's aggressive interest-rate hikes, persistently high inflation, a resilient labor market, rising equity valuations, and a stabilizing housing market have all contributed to stronger-than-expected market gains so far in 2023. Despite recession forecasts at the start of the year, the S&P 500® Index was up about 8% through mid-May.
However, the gains haven't been distributed equally across all market sectors; the communications services, information technology and consumer discretionary sectors have vastly outperformed the financials, utilities and energy sectors so far in 2023. As a result, there's a good chance your portfolio allocation has shifted.
With that in mind, here are some practical tips to help protect your holdings and stay on track for the long-term, even if volatility rises from here.
1. Stay diversified through rebalancing. Diversification is essentially about spreading your investments and risks around. Make sure that you're diversified both within asset classes and across asset classes.
Rebalancing is a way of adjusting your portfolio to keep your risk in line with your objectives. The appreciation or depreciation of individual investments could shift your allocation, and before you realize it, your portfolio could become overly concentrated in just one or two segments of the market. This often occurs because various segments of the market perform differently at different times. That means rebalancing periodically is important—Schwab suggests rebalancing every six or 12 months.
2. Consider exchange-traded funds (ETFs) or mutual funds. In contrast to individual stocks, ETFs and mutual funds can be a good way to diversify your portfolio while avoiding the burden of selecting and buying individual stocks. Schwab offers a variety of resources, from portfolio builders to Select Lists.
3. Revisit your asset allocation. Proper asset allocation—across large-cap stocks, small-cap stocks, international stocks, bonds, commodities and cash, for example—can further spread your investments around and help reduce your risk. When properly allocated, your collective portfolio risk should effectively be lower than any individual portfolio asset.
Since stocks and bonds often react to different stimuli, a single event could cause opposite reactions. And if a single stock or bond turns sour, it will have a much smaller impact on your overall portfolio if it comprises only a small percentage of your assets.
How do you know when markets are volatile?
One handy tool to identify market volatility is Cboe's Volatility Index (VIX). The VIX is based on option contracts linked to the S&P 500 Index and is widely followed by investing professionals as a measure of the market's relative calm or skittishness.
For much of 2023 to date, the VIX has been uncharacteristically low, averaging around 19.57, compared to 25.56 in 2022. While the VIX was extremely low (below 10) for much of 2017, from a long-term perspective, the most common level for the VIX is around 13.
But the VIX tends to spike higher during periods of heightened uncertainty or market turmoil. In March 2023, the VIX briefly topped 26 as the banking sector convulsed. In March 2020, as the Covid-19 pandemic roiled markets around the world, the VIX surged above 82.
4. Take some profits off the table and maintain smaller positions. Holding on to a position larger than you’re comfortable with to maximize gains increases your risk. If you own positions that have increased substantially in value, selling some (but not all) of your shares is a good way to help protect some of your gains while allowing for further potential upside.
During times of higher than average or increasing volatility, a slightly higher cash allocation is often prudent. By taking partial profits on some of your appreciated positions and leaving those proceeds in cash, you can help protect some of your profits and lower your risk.
5. Get some professional help. If you find the daily ups and downs of the market too stressful and exhausting, you might want to let someone else handle it for you. At Schwab, you can get a wide variety of personal guidance: from specialized teams of product experts to fully managed accounts, and everything in between.
6. When in doubt, wait it out. Just as stocks can't go up forever, they also can't go down forever. Periods of heightened volatility come and go but are generally relatively short-lived. If you don't have a good feeling for where the markets are heading, and you're worried that your emotions might cause you to make a bad decision, just ignoring the noise and doing nothing isn't a bad idea. And perhaps most importantly, remember that investing is a long-term endeavor; don't let short-term market volatility distract you from your long-term goals.
Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges, and expenses. Please read it carefully before investing.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income, small capitalization securities and commodities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.
Diversification, asset allocation, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when a nonretirement account is rebalanced, taxable events may be created that may affect your tax liability.
Investing involves risk, including loss of principal.
Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.
Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see www.schwab.com/indexdefinitions.
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