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Retooling Your Investment Portfolio Amid the Turmoil
This year started on a positive note for most investors; 2019 provided stellar returns for almost all asset classes and at the start of the year, it appeared those gains would continue. But we all know what happened next. An extremely fast and deep bear market, widespread business closures and record unemployment damaged the economy.
Yet in short order, markets charged upward just as vigorously as they fell. Remember, markets are forward-looking because prices are based on expected future earnings. Amid this turmoil, investors experienced a real-life test of their true risk tolerance. Some tried to “de-risk” their portfolios and others leaped at the opportunity to buy at a discount.
You probably learned something about yourself as an investor recently. Here are key areas of your financial life to consider in a new light.
Examine Your Risk Profile
Perhaps when you first created your portfolio allocation, your financial advisor or online robo-advisor had you fill out a risk-profile questionnaire. Most investors know the “right” answers to these quizzes. You aren’t supposed to panic and sell when markets are down, so you likely answered in that manner. However, you just took the real-life test of whether you were truthful with yourself.
As markets cratered, did you feel extremely stressed about your portfolio allocation? Did it fall by more than you expected? Did you consider selling during the lows? If so, perhaps your overall allocation is more aggressive than it really should be for your particular risk tolerance.
Perhaps you experienced the opposite. Did the market dip make you wish you were well-positioned to take advantage of the lows? Did you wish you were participating in equity market movements to a greater degree? If so, review your allocation and determine whether you should allocate more to equities.
Many other factors determine your broad asset allocation. For example, when do you need to use the money? Young investors can “afford” more risk because there is more time to recover from a loss. Likewise, if you are a grandparent with an account for your young grandchildren, they likely will not need the money for a long time, so it would be advantageous to take on a bit more risk for more long-term rewards. Generally, money you need in the short term, which is typically within three years, should be invested in a more conservative income-focused manner.
Consider Your Holdings
Mutual fund and exchange-traded fund managers experienced a test of their downside risk management in February and March. An equally important test came in April and May when markets soared. This is a great time to examine how your funds held up relative to their target index benchmark and peers in both situations. Did your funds participate in the losses and gains to the degree you anticipated?
This is also a great time to examine how your mutual funds and ETFs fit within your overall portfolio strategy. Are your funds tax-efficient? Do your funds have high expense ratios, or are you overexposed to any asset class or sector?
Volatile markets also provide opportunities to rebalance. After these wild peaks and troughs, your portfolio allocation may be entirely out of line with where you intended. Examine and rebalance if needed.
Review Your Emergency Reserve Fund
The shutdown caused problems in markets, but also in the wider economy and employment. Many investors faced a double whammy of interrupted or lost income from employment at the same time their equity and bond investments tanked. The dip in bond markets was temporary and has since been addressed in multiple ways by the Federal Reserve’s statements of support. However, if you did not have adequate cash reserves and had to tap into your equity or bond investments at the lows, you would have severely hampered your returns.
It can be a painful lesson to learn, but if you realized that your emergency fund was lacking during the time you needed it most, try to improve those numbers as soon as possible. Keeping at least three months’ worth of your core expenses in an emergency fund is, generally, the minimum “standard” amount, but you may need more.
Examine Your Debt Portfolio
One result of the economic damage exacted by the recent downturn is that interest rates are now at historic lows, near 0%, and the Fed has pledged to keep rates low for some time. This in turn affects U.S. Treasurys and the overall bond market. If you have a mortgage, this might be a great time to examine whether a refinance is prudent. You could also use this time to restructure other types of debt, particularly high-interest or variable debt.
Examine Your Cash Flow
For many, the “stay at home” orders had a silver lining. With nowhere to go, entertainment and dining out expenses plummeted. Now that reopening has begun, think carefully about which costs you want to reinstate. You could vastly increase your ability to save and put yourself in a stronger financial position for the future.
Buy Things
This might sound counterintuitive to the previous point. However, if there are items you had been considering previously, you might find them on sale now. As businesses reopen, many are offering specials and discounts to lure back shoppers. If your cash flow can tolerate it, snag a bargain.
Learn From Experience
All of us have been affected by this global pandemic and all of us can learn from it. Take something positive out of this difficult situation, such as saving more or changing your investment approach. Use this experience to figure out steps to improve your net worth over time.
