Mon, 17 Jun 2013
Morningstar's Christine Benz offers tips on how to handle your portfolio's stock, bond, and cash stakes when markets shake investor confidence.
Jason Stipp: I'm Jason Stipp for Morningstar. Markets have been skittish lately, with some folks talking about a June swoon. So if you're the worrying type and want to check your portfolio's risk level, Morningstar's Christine Benz, our director of personal finance, has some tips for you.
Thanks for joining me, Christine.
Christine Benz: Jason, great to be here.
Stipp: The traditional way of thinking about taking risk off the table is to go to cash. This is what a lot of people will run to when the markets really get bumpy, but that has its downsides, too.
Benz: I think it does, Jason. The big one is psychic. So when you think about these periods where the market's a little bit volatile, sometimes it's not this straight-down plummet. It's kind of sideways, and you wonder, "Did I get out prematurely? Is it time to get back in." So coming into the market with a lot of cash really can provide headaches of its own.
Stipp: So you have some tips where people can do some things in their portfolios that actually will help control risk, but they're not as drastic as just moving everything into a cash account. The first one you say is kind of boring. It might be something that you would tend to do anyway during the year, but now could be a good time to take a look.
Benz: That's right. We've had a great run [in the stock market], so I think it's time to rebalance potentially out of stocks if you haven't looked at your basic stock/bond/cash weighting recently. It's probably time to peel back on the equity piece, and so you would want to think about rather than moving the money directly into bonds, which arguably aren't attractive either, you might think about taking at least some of that money you'd otherwise have earmarked for bonds and leave it in cash, and then sort of dollar-cost average into bonds. I think that we probably will see yields go up in the years ahead, and you'll have some better buying opportunities down the line than you do today. So I think that's a good first step, use Morningstar's X-Ray tools, check your baseline asset allocation, and see if any tweaks are in order.
Stipp: So the biggest impact is going to come from your stock and bond split at a high level, but you're saying it's also worthwhile to dig into some of the subasset classes, for instance, on the bond side.
Benz: Absolutely. So that's one I would really take a hard look at right now. We've had a great run in some of these noncore categories; I would say bank loan, for example; high-yield has had quite a good run; long-term bonds until recently had a good run. So I think you want to think about peeling back on risk at this time. I think it's not a great time to be doing anything too creative with your bond exposure. You probably want to keep it relatively short-term, so stick with short- and maybe intermediate-term bonds. And also keep the quality relatively high, peel back on some of those noncore categories that have performed really well.
Stipp: What's your take on the cash stake right now? How should you think about cash as part of that asset allocation?
Benz: I think when you look at the yield differential between cash and bonds, certainly short-term bonds, it's minuscule right now. So there's not a great opportunity cost for holding cash. I think cash actually looks pretty attractive, and then potentially thinking about dollar-cost averaging into bonds, as I said, as yields go up, I think that's a good strategy.
Stipp: What about for the stock piece? So I'm not going to sell all my stocks as we talked about before, but if I do want to take some risk off the table with that stock allocation, what might I do in the equity portion?
Benz: Well, valuations aren't especially cheap right now, so I think you want to shade to the left-hand side the Morningstar Style Box, meaning that you'd want to have a little bit more value exposure in your portfolio than growth. It's true that year to date, value has outperformed growth, but I still think that you'd want to make sure that you have a good value bias in effect, or have value-oriented managers working for you. They'll be able to pick through the wreckage if the market continues its downward trend and will be potentially able to find opportunities. So I would focus there.
Stipp: And among the stock and bond funds that you might have, or just both of the asset classes, you're saying take a good look at the winners that you have in your portfolio and decide how far they have run and how much more they could maybe go at this point.
Benz: That's right. So I think if you're looking at a fund that you own and you see top-decile category rankings across the board--and there are some great funds that are exhibiting those kinds of numbers right now--I think you want to poke hard at them and maybe think about scaling back because performance has been very, very good. There is a phenomenon called reversion to the mean. We see it even with very good managers, where after a winning streak sometimes performance cools off a little bit. So don't be tempted to give all your money to those managers who have done very, very well. In fact, I'd be inclined to do just the opposite and do a little bit of rebalancing. If you have high-conviction managers who haven't done as well, send the money their way rather than to the hot-performing funds.
Stipp: Psychologically speaking, market turbulence can really be a tough time to make good investment decisions because they're stressful. So you have some tips to psych yourself up for some market volatility, and the first one has to do again with that cash stake.
Benz: Right, making sure that you have cash on hand to potentially put to work if the going gets tough for the market. I would say if you haven't made that 2013 IRA contribution, that might be a good time to think about deploying the money, if in fact the market starts to take a tumble. So I think psych yourself up, make sure that you have some dry powder, make sure that you also have a watchlist, things that you would like to invest in if they get cheap enough. So you can take a look at Morningstar's Stock Screener tools. For example, look at companies that rank highly in terms of having good moats and other good characteristics but maybe aren't trading particularly cheaply right now; keep an eye on those. You can create a watchlist on Morningstar.com of things that you might like to buy in a potential sell-off.
Stipp: If you're a fund investor, there are some managers who can do quite well for themselves during times of market dislocation.
Benz: Again, this comes back to value-oriented strategies or perhaps even truly opportunistic managers. I think of a fund like FPA Crescent, for example, kind of a go-anywhere-type product. I think it can make sense and feel good to know that you have a manager like that working on your behalf in times of market turbulence.
Stipp: Well, Christine, we hope that we don't see that market turbulence, but if things do get bumpy, we'll all be better off thanks to your tips. Thanks for joining me.
Benz: Thanks, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.