By Charlie Wells, Claire Ballentine and Suzanne Woolley
Investors knew this year would be different. But lately, they’ve been getting a lesson in just how different it is shaping up to be.
Most analysts expected some action on interest rates from the U.S. Federal Reserve in 2022 — but maybe not the five rate hikes they’re now pricing in. Inflation was clearly driving upwards, but we’re seeing much higher, more consistent price increases. People have been moving their money away from growth-led tech companies and toward those in the value category, or stocks considered underpriced. And banks are now forecasting slower growth in the months ahead. All this is creating a wave of volatility not seen since the start of the pandemic era.
The Nasdaq Composite had its worst month in nearly two years in January, falling 9%. Massive intraday reversals made it difficult for retail traders — who have grown accustomed over the past two years to buying dips only to see them rise again — to time the market. Up until late January, confidence had been running high among the retail crowd, who’ve fueled speculative excesses across markets from cryptocurrencies to meme stocks. But both have been trending downward for months. And now, shifts in the situation in Ukraine are keeping volatility gauges well above 12-month averages.
“It’s a new investment regime, and the things that have done well the last couple of years probably aren’t going to do well in the next couple,” said Ben Laidler, global market strategist at the platform eToro. “Interest rates are going up, growth is slowing, returns are going to be lower, there’s going to be more volatility. That is the new reality.”
What does this mean for your portfolio? Investors who know how to take advantage of the changes in the market stand to profit from new opportunities. Those who don’t — or those who think they do but are mistaken — stand to lose out. To help guide you through these changing markets, Bloomberg News polled financial advisers and other experts for their best suggestions for retail investors. Here’s what they told us:
Gut check your risk tolerance
Putting 70% of your portfolio in tech stocks may have felt great when they were going up. But what about on a day like Feb. 3, when Meta Platforms Inc., Facebook’s parent company, faced the biggest wipeout in stock market history, erasing $251 billion in value. The company had been a star of the pandemic era, climbing 127% from March 2020 until early January of this year.
Conditions are rife for such dramatic changes. Yet an investor who finds out in the middle of a downturn that they’ve overestimated their tolerance for risk may wind up being their own worst enemy. The classic mistake is selling into a downdraft and locking in losses, and then sitting out the market’s eventual rebound.
There are simple ways to keep your nerves in check. Behavioral-finance studies have shown that the perception that investing is risky is heightened among people who check portfolios frequently, said Randy Bruns, senior financial planner at Naperville, Ill.-based Model Wealth.
Basically that’s because the odds of someone seeing a loss in their account are greater if they check it more often. If an investor looked at his or her portfolio daily, the chance of seeing a moderate loss of 2% or more was 25%, research has shown. But checking quarterly, the chance of coming across a loss like that fell to 12%.
One way to limit how painful a loss may feel is to look at portfolio returns in percentages, not dollars. “While a $30,000 loss may sound catastrophic, a 3% ‘paper’ loss off your million-dollar portfolio when the Nasdaq’s down 15% may be appropriate and in line with your goals,” Bruns said.
If you just can’t stop checking your portfolio, you can build in obstacles. There are Chrome extensions you can download to limit the amount of time you allow yourself to spend on a certain site, like Limit or StayFocused. Another idea that could be effective — as long as both parties consent willingly — is to allow your spouse to control your account login information, said Ashton Lawrence, a financial planner at Goldfinch Wealth Management in Greenville, S.C.
Make sure you’re as diversified as you think you are
Most investors know the benefits of diversification. Spreading your money across industries, broad sectors or different countries helps lessen the risk of losses in a particular area. In a volatile market, losses may be even less predictable. Few could say, for instance, that they saw Meta’s historic drop coming.
The trouble is, many investors may think they’re diversified. But dig in under the hood, and you’ll find more of the same, same, same across a portfolio.
“One major misconception about volatility is the narrative around the S&P 500,” said Craig Toberman, founder of Toberman Wealth in St. Louis. “The S&P 500 as commonly discussed is ‘market-cap-weighted.’ That is, there is no rebalancing feature built into the index. When stocks go up in price they, by definition, take on a greater share of the composition of the index.”
This means that an exchange-traded fund that tracks the index — often viewed by investors as a surefire way to diversify — can be heavily weighted toward the largest companies. Toberman points out that right now in the Vanguard S&P 500 ETF, the top 10 companies make up over 30% of the fund. Many of those companies are in the tech sector and include not just Meta but also Apple Inc., Microsoft Corp. and Tesla Inc.
It’s not just ETFs. Many retirement funds that many Americans assume are diversified are heavily weighted tech. A handful of mega-cap tech stocks make up more than 45% of some of the most popular funds in retirement plans, according to data compiled by Bloomberg.
Toberman recommends that investors consider S&P funds with an “equal-weighted” basis. Within such funds, every stock has just 1/500th of the weighting. This means that the top 10 hold just 2% of the fund. Such funds may have higher fees than their market-cap-weighted peers because they require a bit more management, Toberman said.
Another thing to consider is buying smaller companies, balancing out those with ginormous valuations.
Be careful with the label ‘low volatility’
Other exchange-traded funds claim to offer protection from wild market swings, but they have varying degrees of effectiveness.
The “low-volatility ETFs” include stocks whose prices have historically fluctuated the least, typically heavy in defensive sectors such as utilities and consumer staples.
But those might not do well, depending on why the market is falling. When the onset of the pandemic rattled markets in 2020, low-volatility ETFS performed dismally since investors turned toward tech stocks and other work-from-home beneficiaries.
That could change this year.
“If we are in an environment where investors hide out in Meta and Alphabet, then this ETF isn’t going to do well,” said Todd Rosenbluth, head of ETF and mutual fund research at CFRA Research. “But if investors hide out in companies like Procter & Gamble and Pepsi, then this ETF will hold up much better.”
Two of the largest low-volatility products — the S&P 500 Low Volatility ETF (SPLV) and the S&P 500 High Dividend Low Volatility ETF (SPHD) from Invesco — lagged behind the S&P 500 late last year, although they were outperforming it at times in 2022.
For those who want extra protection against losses, a class of funds called “buffer ETFs” could help, with a catch. These products, also called defined-outcome funds, use options to smooth drops over a certain time period, usually a year. You won’t have to deal with complicated options strategies yourself. That means, however, you could miss out on big gains if stocks rally.
Another choice is “covered call ETFs,” which invest in equities while using options to generate a steady income stream.
“They can be a replacement for fixed income because they’re designed to hold up better, and it gives you the income you would want,” Rosenbluth said.
Define your bond time-horizon strategy
Bonds are back in fashion, seen as a safe bet when equities struggle but better than cash.
Rosenbluth is a fan of short-term bonds, which usually mature in one to five years, because they’re less sensitive to rising interest rates.
“They’re a good place to park your money and stay liquid and earn a little bit of income,” he said.
Noah Damsky, an investment adviser at Marina Wealth Advisors in Los Angeles, is a fan of long-term bonds. “I’m buying as I expect the interest rate curve to flatten once the Fed begins hiking rates as aggressively as the market is pricing in,” he said.
In either case, don’t use them as a complete cash alternative, said Elliot Pepper, a financial planner and director of tax at Northbrook Financial in Baltimore. Even though inflation will eat into the value of your cash, having some dry powder to make moves could help investors take advantage of unexpected opportunities.
“The ability to have that cash to put to work for you, that’s what separates the investment superstars from the people who are just going to ride the market,” Pepper said.
Liz Ann Sonders at Charles Schwab urges caution on an increasingly popular type of bond: TIPS. Short for Treasury inflation-protected securities, they are designed to shield investors from a decline in the purchasing power of their money. That may sound appealing given inflation ticking higher, but their moment may have passed.
“At the early stages of the pickup in inflation we had a more positive outlook on TIPS, but then they became so popular, and that caused the price to go up and the yields to go down,” said Sonders, the firm’s chief investment strategist.
Rethink real estate
Our homes are often our biggest investments. As real assets, properties can often function as solid hedges against inflation. And in most times, real estate values serve as a healthy check against stock-market volatility because property prices swing less than trendy equities.
Still, with the housing market in many countries still red-hot, real estate may be out of reach for average investors. That’s why experts recommend getting some property exposure in a portfolio through real estate investment trusts, or REITs, which focus on different types of properties, ranging from apartments to manufactured homes to warehouses. REITs must pass through 90% of their taxable income to shareholders as dividends in order to avoid paying federal taxes.
Cedric Lachance, director of global research at real-estate research and advisory firm Green Street, has the most confidence in REITs that are “roofs above heads” since the residential component of REITs tends to be a good inflation hedge. REITs that focus on single-family housing, manufactured homes or senior housing are the most attractively priced now, he said.
Since much of a REIT’s payouts to shareholders is taxed at ordinary income rates — rather than the lower, longer-term capital gains rate that applies to the so-called qualified dividends that an investor might get from owning individual stocks — owning REITs in a tax-deferred IRA or a 401(k) often makes sense.
More stories like this are available on bloomberg.com.
