How to invest when the stock market and the bonds are down
A balanced portfolio between stocks and bonds has been a classic strategy for investors throughout market history. Although stocks generally outperform long-term bonds, the stock market can be volatile. Bonds generally move opposite to stocks in price, so these fixed income securities have traditionally been used to help smooth a portfolio’s trajectory when stock markets feel like a rollercoaster. However, so far in 2022, there has been a radical change in this relationship. Due to a combination of rising rates, inflation and slowing economic growth, we have seen stock and bond prices fall sharply at the same time.
This break from the norm has rattled investors around the world, with many wondering where to go from here. A lot can depend on the time horizon and situation in a person’s life, but there are a few courses of action that can be considered.
Breathe. Although drastic, there is an abundance of evidence that shows that time will return this complementary relationship to a more normal state.
Rebalance. Although both asset classes have fallen, bonds have held their value more than stocks at this point. Adjusting your holdings to the desired mix during periods of volatility could benefit you, as buying falling stocks can produce outsized gains compared to holding the same bonds.
Reduce the duration. As their relationship is inverse, a rise in interest rates from near historical lows was the main cause of the decline in bonds. If the rates continue to rise, the longer-term bonds will continue to underperform. Reducing the average duration, or duration, of your bond holdings could reduce future principal fluctuations in that part of the portfolio. Remember that a lower duration can mean a lower yield on your bonds, so make sure you’re comfortable with the trade-off.
Consider more diversification. Although most investors consider stocks, bonds and cash as the three main pillars of the asset class, “real assets” are considered a fourth. Underutilized due to a decade of relative underperformance, this category focuses on assets that can be physically impacted. Agriculture, real estate, energy, as well as base and precious metals can fall into this category. Historically, physical assets have performed well in an inflationary environment, especially relative to fixed income securities. If inflation stays high for a while, it can add another layer of stability to a balanced portfolio. However, investing in real assets can be complex and there are big differences between some of the sub-categories. Many investors would be wise to fully educate themselves on their various risks and dynamics or utilize specific expertise when considering adding it to a portfolio.
All of this may be easier said than done, especially in times of economic volatility like the one we are currently experiencing. It’s best to compare all the options and come up with a long-term game plan before making any changes. Whichever path you take, maintaining discipline in the future requires knowing why you chose it in the first place.
Trevor Conlon has more than 20 years of experience as a financial advisor. Its main activities are in individual asset and portfolio management, income generation, retirement planning and 401(k) plan advisory services for businesses. He is an alumnus of LaSalle University in Philadelphia. Contact [email protected]