Investment portfolio tactics in a challenging market

September 28, 2022 | Market News

Key takeaways

  • Consider tactical positioning, which involves making modest, temporary asset allocation adjustments within your investment portfolio relative to your long-term target allocation.
  • Dollar cost averaging, which involves investing a portion of the cash balance into the target portfolio through regular intervals, may limit the magnitude of investor regret as the market moves up and down.
  • Rebalancing among asset classes with the most significant differences in return and risk, such as stocks and bonds, can enhance long-term returns and is effective at managing overall portfolio risk.

Challenging investment performance has been a 2022 hallmark, with investors experiencing losses across most major asset classes. In the past, bond market returns have provided a positive performance offset during periods of stock market declines. However, high inflation, rising interest rates, a European conflict and the ongoing coronavirus pandemic have all contributed to downward pressure on both bond and stock prices. Only a few, narrow slices of the capital market landscape have provided any respite from price pressures, such as the volatile energy complex and very short-maturity fixed income investments, like money market funds. (See the table on page 2 for a summary of year-to-date asset class performance).

Such challenging market performance periods lead investors to question what to do to align your portfolio toward your long-term investment plans and goals. We suggest three situational tactics to consider in the current market environment: Tactical positioning, dollar cost averaging and rebalancing.

Tactical positioning involves making modest, temporary asset allocation adjustments within your investment portfolio relative to your long-term target allocation. These adjustments reflect our current assessment of capital market trends and relative risk and return opportunities among asset classes. For our latest thinking contact your wealth management advisor or visit Market News on usbank.com.

Investors often accumulate cash in their portfolios through interest, dividends, or perhaps through security or business sales proceeds. Investing cash into higher-returning asset classes in the long-term is critical in meeting long-term financial goals. However, challenging markets often leave investors uncertain regarding timing of investing cash into their long-term plan. One strategy to consider is dollar cost averaging.1 This involves investing a portion of the cash balance into the target portfolio through regular intervals rather than trying to invest the cash all at once (a practice called lump sum investing). Our research showed that lump sum investing produced the highest average historical returns; however, investors may experience regret if markets slip further. In this case, making regular transitions from cash into the target portfolio, over as many as two years if starting from an all-cash position, may limit the magnitude of investor regret, which we define as the average number of months the portfolio spends below its initial value.

Lastly, investors should consider regularly rebalancing2 their portfolio. Asset prices can move in different directions and at different speeds, and these return variations can move your portfolio allocations away from your long-term strategy. Recent market volatility likely means many portfolios are misaligned with long-term goals, especially as some key asset classes have experienced performance differences of more than 10%. The table below details performance across a variety of market indexes through August 31, 2022. Our analysis finds periodic rebalancing among asset classes with the most significant differences in return and risk, such as stocks and bonds, can enhance long-term returns and is effective at managing overall portfolio risk. We first suggest evaluating your relative stock/bond allocation and using the recent significant performance differences to nudge your portfolio back toward its target allocation. Additionally, within an asset class such as mid-cap U.S. stocks we suggest examining allocations where growth and value style performance has materially diverged.

Asset Class  Total Return (%)
Fixed Income YTD* 2021 2020 2019
Bloomberg U.S. Aggregate Bond -14.61 -1.54 7.49 8.72
Bloomberg Municipal Bond -12.13 1.52 5.20 7.54
ICE BofA U.S. high yield -14.62 5.37 6.15 14.42
U.S. Treasury 90 day T-Bill 1.01 0.04 0.36 2.06
Equity YTD* 2021 2020 2019
S&P 500  -23.87 28.73 18.36 31.51
Russell Mid Cap Index -24.27 22.60 17.06 30.57
Russell Midcap Growth Index -31.45 12.74 35.50 35.50
Russell Midcap Value Index -20.36 28.36 4.95 27.08
Russell 2000 Index -25.10 14.83 19.92 25.54
MSCI EAFE Index -26.76 11.78 8.26 22.67
MSCI EAFE Growth Index -32.82 11.59 18.64 28.46
MSCI EAFE Value Index -20.61 11.59 -2.10 16.84
MSCI Emerging Market Index -26.89 -2.22 18.65 18.91
Real Assets YTD* 2021 2020 2019
DJ Equity All REIT Index -28.06 41.34 -4.07 28.69
FTSE Global Core Infrastructure -13.29 17.86 -0.66 26.28
*YTD Period ending 9/30/2022. Source: Morningstar. See index descriptions in the disclosure.
Past performance is no guarantee of future results. Returns shown represent results of market indexes and are not from actual investments and are shown for ILLUSTRATIVE PURPOSES ONLY.

Conclusion

This year’s turbulent market performance disrupted some long-term investment plans and portfolios following strong recent year returns. With major asset classes delivering disappointing performance, investors may ask what to do next. We offer three potential solutions depending upon your specific circumstances. First, consider a tactical adjustment to align your portfolio with current market concerns and risks, contact your advisor for our latest thinking.

Second, if you find your portfolio holds excess cash, consider a dollar-cost averaging plan to start investing cash and fully invest your portfolio in the next year or two. Third, diverging asset class performance opens the opportunity for rebalancing. We suggest bringing your stock and bond mix back toward your target allocation and examining allocations within asset classes, such as mid-cap U.S. stocks or developed foreign stocks, to bring divergent investments closer to long-term target allocations. Your wealth management advisor can be instructive in blending and selecting strategies to keep your portfolio on target for your long-term investment plans and goals through this challenging market environment.

 

This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.

Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities, asset-backed securities and commercial mortgage-backed securities. The Bloomberg Barclays U.S. Municipal Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar denominated, fixed tax-exempt bond market. The index includes state and local general obligation, revenue, insured and pre-refunded bonds. The ICE BofAML U.S. High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe and is a subset of the Russell 1000 Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap Growth Index measures the performance of the mid-cap growth segment of the U.S. equity universe. It includes those Russell Midcap Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell Midcap Value Index measures the performance of the mid-cap value segment of the U.S. equity universe. It includes those Russell Midcap Index companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. The MSCI EAFE Index includes approximately 1,000 companies representing the stock markets of 21 countries in Europe, Australasia and the Far East (EAFE). The MSCI EAFE Value and Growth Indices covers the full range of developed, emerging and All Country MSCI Equity Indices. The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. The Dow Jones Equity All REIT Capped Index is designed to measure all equity REITs in the Dow Jones U.S. Total Stock Market Index, as defined by the S&P Dow Jones Indices REIT/RESI Industry Classification Hierarchy, that meet the minimum float market capitalization (FMC) and liquidity thresholds. FTSE Core Infrastructure Indexes include companies that derive a minimum of 65% of their revenue from core infrastructure activities. Companies with revenue only attributable to infrastructure-related activities are not eligible for the indexes.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer's ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).

U.S. Bank and its representatives do not provide tax or legal advice. Your tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.

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