Something that can be helpful on days like today, if only psychologically, is to consider how you would invest a portfolio if you were starting from scratch.
It's so easy to get caught up with the emotions -- positive and negative -- assigned to each of your existing holdings that it can seriously alter your view of how you should be positioned for current market conditions.
While Friday and today certainly felt correction-like for the first time in a few months, chances are portions of your portfolio have already been in correction territory for some time. Despite the fact that the Dow and S&P are both within 3% to 4% of their respective all-time highs, there has been an enormous amount of volatility in individual stocks and sectors the past six months.
The movements of some critical economic factors listed below are some of the culprits:
1. The 10-year Treasury is at about 2.13% today, down from over 2.5% six months ago but up from 1.7% just five weeks ago. That means the 10-year rate moved lower by 25% (from 2.5% to 1.7%) and since then has moved 25% off that level. These are enormous moves for such an important interest rate index. As a result, long-dated bonds have been on an even wilder ride than most energy stocks.
It would be easy to see the typically stable fixed-income side of your portfolio moving around this much and determine that you are improperly positioned for what's to come. Should we reduce duration? Hedge this portion of our portfolio by shorting bonds? Increase or decrease the credit quality of our holdings?
2. Speaking of energy stocks, we all know where oil is currently trading -- below $50 and $60 (West Texas Intermediate and Brent Crude, respectively). That's down from nearly $100 a barrel on both just six months ago.
The stress in all parts of the energy patch is obvious, and even those who thought their exposure was minimal have likely felt the impact in the fixed-income portion of their portfolio. While I can't quantify how much oil's volatility has contributed to bond market fluctuations, this chart presents a pretty clear picture:
3. As of today, a euro costs $1.07USD. Six months ago, it cost $1.30USD to buy one euro. Another enormous move -- my guess is that most Americans may know the dollar has been strengthening, but not necessarily the impact it is having on our trading partners. Yes, we are a consumer economy, so a strong dollar improves our ability to consume goods produced in other parts of the world. Is that good for U.S. employment? How does it help the Fed achieve some modicum of inflation, the importance of which is being severely underestimated?
The three pieces of data listed above are not news to anybody. But any one of them on its own would be enough to create uncertainty in the markets and fear among investors.
It's important, though, that we not allow short-term gains or losses to influence what we think of our portfolio.
It is theoretically possible that I bought a long-dated Treasury bond six months ago and watched it appreciate by almost 20% through January. But it has since given half of that back. And if I bought the same bond five weeks ago, I'm down 10%. That may not sound like much, but consider that with the 30-year Treasury yielding just 2.7%, a 10% move represents almost four years' worth of income. That's enough to make a retiree queasy.
Great -- we all know what happened over the last six months; so what do we do now?
Looking at a portfolio after a period of such volatility can give you an unfair and unclear picture of how you may be positioned for the future. It's tough to let go of holdings that have "treated you so well" during tumultuous times and, similarly, to hold on to those that have struggled.
Take a step back and consider the hypothetical scenario where you are starting from scratch. Whatever your portfolio value is right now -- assume you have that much sitting in cash. What would you want to buy? What would you want to avoid? If your portfolio doesn't look very similar to what you come up with, maybe it's worth making some changes (provided you can do so without large tax implications).
But if the "ideal portfolio" you build looks just like the portfolio you have, maybe nothing needs to change. Maybe you are being influenced, understandably, by how much things have been moving around.
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