Video: New Year, New Risks – Keeping Your Portfolio In Balance
Wednesday, January 5th, 2022
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Stephen – Hello and welcome to another episode of the Smart Money Show. I’m your host, Stephen Rischall, along with my co-host, Chris Carter. On today’s episode, we’re talking about some of the most important things on investors’ minds as we kick off the new year, so let’s get started.

Wow, 2021 was definitely one for the record books. Since the start of the COVID-19 pandemic, we’ve experienced major health concerns, a shutting down of the global economy, record unemployment, political turmoil, supply shortages, and the list goes on. But even still, over the past three years, the stock market has been on an absolute tear.

We ended 2021 with the S&P 500 up over 28%, and in 2020 and 2019, the stock market was up 18% and 31%, respectively. Now, that certainly came with a lot of volatility along the way, so what does that really mean for your portfolio today, Chris.

Chris– Yeah, well, Stephen, those numbers are pretty eye popping and honestly reminds me of when I was just starting in the business in the mid-to-late 90’s there was a stretch where we saw these kinds of returns so, really remarkable.

I’m sure you’ve heard us talk about asset allocation, your mix between riskier investments, like stocks and real estate, and less risky investments, like bonds. Long term, this mix is really what ultimately determines the risk profile and reward of your portfolio, and it’s really important to keep an eye on this.

For example, let’s say you have a 60/40 mix as your target, and that’s 60% in the riskier more growth types of investments and 40% in the more conservative types of investments. Like Stephen said, the stock market has done so well recently, these riskier investments, they’ve gone up a lot over the past few years.

So, right now your portfolio might look more like 65% or 70% in the riskier, growth investments. Now, we allow this mix to fluctuate somewhat, but when it gets too out of whack, as we call it, we like to rebalance. Think of this like resetting the portfolio back to that original 60/40 target.

The primary function of rebalancing a portfolio is to control risk. Since riskier assets are more volatile, but they also tend to outperform safer investments, it’s normal that over time their proportional share does grow. This means the risk of the portfolio drifts from that target, making your portfolio, you know, more risky maybe than you are comfortable with.

So, rebalancing controls this risk by moving money between investments to re-establish that target asset allocation. We are doing this for many of our clients right now.

Taking it a step further, we also like to rebalance inside of the risky portion and conservative portion of your portfolio. For example, US stocks, as Stephen showed earlier, have done extraordinarily well and have outperformed International stocks. So in practice, rebalancing just means selling high, and buying low, which is a hallmark of disciplined investing.

Stephen – Yeah, that makes a lot of sense, Chris. The long-term trend for the market is to go up, so trimming an investment or asset class that has performed really well, and shifting money into other areas of the market. It can improve returns, and more importantly manage risk, long term.

Now aside from rebalancing due to asset class performance, there’s a few other things we’ve been watching closely that effects these decisions. One of those is inflation.

By now you’ve probably felt it in your pocketbook. I’ve certainly noticed that every time from filling up gas in my tank, to filling up my fridge with food, it seems to be a lot more expensive these days. Perhaps the biggest questions on investors’ minds today is about inflation.

How high will it go and how long will it last?

Now Chris, you’re a bit older than I am, since I was born neither investors nor the Federal Reserve has had to contend with meaningful inflation, like we’re seeing today. But that changed in a big way this past summer. So, what happened?

Chris – Well, first of all, thanks for reminding everyone of our age difference. Appreciate that. But as you can see on the screen here the inflation numbers the past 5 years up until 2021, you know were very modest, but now a whooping 6.8% based on the CPI, right.

So, when increased demand met supply restrictions it created this imbalance in the economy. And that caused prices to rise rapidly. Some of these price increases were to be expected as the uneven re-openings from lockdowns disrupted supply chains. The rise in energy prices and the impact of the semiconductor-chip shortage on car prices.

I don’t know how many of you have rented a car in the past year or so, but there’s some real eye-popping rates that they were charging. It also played a significant role in pushing inflation higher. These issues are slowly being resolved and inflation may not peak sometime until later this year.

But, it’s possible inflation could exceed 7% in the US, but we think inflationary pressures should subside in the second half of 2022 as the supply side of the global economy improves and catches up with demand. One of the main uncertainties is the job market. People have been slow to come back to the labor force due to a combination of stimulus payments, challenges for working parents and frankly, some folks choosing early retirement.

We do expect most of these workers will eventually return. But if the tight labor market continues there could be wage pressure and that inflation number could move closer to maybe 3% or maybe even a little bit higher by the end of 2022. So, this will be important to watch as the year unfolds.

But it’s important to know that investors worried about the potential negative impact of inflation on their portfolios should consider this: Even through times of higher inflation, stocks and bonds have generally provided solid returns. In fact, it’s mostly at the extremes, when inflation is above 6% or negative, that financial assets have tended to struggle.

Stephen – Well then Chris, it sounds like some inflation can be a healthy thing for the economy, but too much, or negative inflation, AKA deflation, for too long. That’s not so good.

But what about interest rates? That’s another thing that’s on investors minds today. The Fed has kept interest rates really low for quite a while now, and we know that the Fed can have a big impact on financial markets. They can use interest rates, to try and control all sorts of things, like inflation to some degree right?

Chris – Right, absolutely. And the Fed always has a big impact on financial markets, and we think they will continue to play a big role in 2022, but for somewhat different reasons. You know, really, after taking unprecedented measures to stimulate the recovery, the Fed is now looking to step back and end – or “taper”, as they call it, its bond purchases in anticipation of raising interest rates back to what it considers a more neutral policy of about 2.5%.

This puts the Fed on track to stop buying bonds by March of this year, so in just a couple months here and that clears the path for them to raise rates shortly, you know, after that. The Fed does need to be very careful with how it begins this tightening because the market is very sensitive to this action.

You know, the old adage of “Don’t fight the fed” has played out the past few years as they have injected massive liquidity into the economy. But dialing this back may not be as simple as it sounds. The market’s volatility last month is an indication of this and we could see more of that volatility in 2022 as the market and the Fed settle into this new reality, this new policy.

It’s very hard to predict how this will play out but it looks like the market has accepted that the Fed will taper its asset purchases more quickly than had been expected. It’s very possible that by the time the Fed does needs to make rate decisions inflation and economic growth will look quite different than they do today.

So, you know we think the 6% or 7% inflation that you mentioned earlier is not going to persist. And we also think the Fed is likely to follow through with tapering bond purchases and increasing interest rates through the rest of 2022.

Stephen – Right, and let’s not forget about this COVID Omicron variant that’s spreading quickly. And just today, I read a story about a new variant that appeared in Europe. I think in France.

In fact, even though I’ve had the vaccine and my booster, I recently tested positive for COVID. Fortunately, I experience very mild symptoms. I’m OK now, but that’s not the case for everyone. While it does seem vaccines and boosters help, and these recent variants are not as deadly, this is certainly a lingering risk for a global economy, especially one that is still in recovery mode.

Chris – Yeah that’s right, Stephen, and obviously we’re glad you’re OK. We all know, I think we all know a lot of people that, certainly in the last couple weeks, that have dealt with COVID. So hopefully everyone, out there that has experienced that is okay.

It does seem likely we will be, you know, living alongside COVID for some time. As we said before, humans adapt to their environment. We are wired to survive.

But, you know, I’m not convinced well be seeing any shutdowns like we had earlier during the pandemic. And if so, with more people able to work remotely, advancements in therapeutics and other technologies, ultimately, we will prevail.

Stephen – Yeah, I agree with you Chris, COVID is certainly a lingering risk and it’s proven to affect some more than others, both physically and financially.

So, with all these changes and recent stock market performance, it’s important to take a look at your asset allocation, rebalance your portfolio so it aligns with your risk/reward comfort zone.

Inflation is still at a much higher level than we’d like to see it, and it’s lasted longer than we expected. Hopefully this too subsides.

And interest rates, they certainly seem poised to continue rising, so we’ll be keeping an eye on how quickly these things change through rest of 2022.

If you have questions about your portfolio, or just want to catch up, now is a good time to review your financial plan and make necessary updates.

And if you learned something new or found this information helpful, be sure to share this video with your friends and people you care about, because they might be thinking about some of these things too.

Until next time, I’m Stephen Rischall, that’s Chris Carter, and thanks for tuning in to the Smart Money Show.