The bull market has been good for stock investors, with the S&P 500® Index climbing from roughly 675 in March of 2009 to nearly 2,200 this summer. While that has been good news for stock investors, even amid the positive returns it is worth taking a look at one of the unintended consequences of a market rally—the rise in stock prices may have added unintended risk to your portfolio.
The big run-up in U.S. stocks has outpaced foreign markets, bonds, and cash. That may have left more of your portfolio in U.S. stocks than you had planned. While overweighting U.S. stocks would have actually helped returns in recent years, it may warrant a close review. This is because, historically, as a portfolio becomes more stock-heavy, it has experienced bigger price swings than a more conservative mix of investments. Bonds and cash may have lagged in recent years, but they have the potential to help a portfolio during downturns, as they did in 2008.
“We think that choosing a mix of stocks, bonds, and cash based on your goals and financial situation is a vital part of being a successful investor,” explains John Sweeney, Fidelity executive vice president of retirement and investing strategies. “But just setting that mix isn’t enough. To reap the benefits of your plan, you need to revisit your investments as the market moves and your situation changes. If you haven’t rebalanced your portfolio over the last few years, you may be surprised at how much additional risk you are now taking on.”
Higher markets and risk levels
Let’s say the last time you decided to rebalance your portfolio was during the bear market in January of 2009. Since then, the market will have made some big changes to the investment mix. The hypothetical portfolio above shows how U.S. stocks went from 49% of the portfolio to 66%, while the proportion of bonds in the portfolio was cut by more than a third.
The challenge for investors is that more stocks come with more risk. By August 2016, the portfolio shown above would have had a risk level roughly 17% greater than the starting mix in 2009. (To measure risk, we use annualized standard deviation; see the disclosure at the end of this article for more details.)
“There is nothing wrong with having more stocks in a portfolio. In fact, many investors need to take on risk to meet their financial goals,” says Sweeney. “But that decision should be a result of your planning process, not dictated primarily by the markets. If you do have a lot more risk than your situation warrants, that could be a recipe for trouble if volatility returns.”
The case for a periodic investment review
Rather than let your investments drift with the markets, it may make more sense to rebalance your holdings periodically—say once or twice a year—or when your mix drifts a set amount from your target. For instance, you may allow your mix to fluctuate a maximum of 10 percentage points above or below the level you target.
If you need to make a change, you can trade out of one holding and move money into another, but be sure to consider transaction charges and taxes before making any changes. Another approach is to target future investments to bring your mix back in line with your plan. For instance, if your portfolio has tilted toward stocks, you could consider directing your next few contributions to your investment portfolio toward bonds or cash.
Along with rebalancing, you will want to make sure that the mix you are using reflects your current goals and situation. So at least once a year, or in the event of a major change in your life, you should sit down and revisit your approach. It also makes sense to review your individual stock and mutual fund holdings at this time, as well as some other basic financial plans. (Read related Viewpoints, "Give your portfolio a checkup" and "Five reasons an annual review is crucial.")
“An investment portfolio takes a little bit of routine maintenance to stay on track,” says Sweeney. “When everything seems to be going well, it’s worth taking a moment to make sure you are ready for the day when things aren’t.”
- Call Fidelity to schedule a review with an investment representative.
- For professional portfolio management and rebalancing, consider a managed account.
- For help analyzing your accounts, choosing a target asset mix, and rebalancing your portfolio to bring it in line with that target mix, visit Fidelity’s Planning & Guidance Center (login required).
Past performance is no guarantee of future results.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917