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Investing Specialists

Top 6 Portfolio Moves for 2023

While the market environment remains uncertain, there are a few key changes worth considering.

Check in to See Whether You Need to Rebalance

If it’s been a while since you checked the asset-class weights in your portfolio, it might be time to make some adjustments. When rebalancing, I like to start with the broadest level (the mix of stocks and bonds) and also consider the weights within each asset class, such as domestic and international stocks and growth and value issues.

On the equity side, value stocks have fared significantly better than growth issues over the trailing 12-month period through Nov. 30, 2022. If you started out with equal weights between the two a year ago, your portfolio might now be heavy on value and light on growth.

If it’s been three years since your last portfolio rebalance, your portfolio might now be light on bonds, even after the historically steep losses in bonds in 2022. That’s also true for investors who haven’t rebalanced over a longer period, such as five years. Because of the large performance gap between U.S. and non-U. S. stocks over that period, investors would also probably find their portfolios underweight in international stocks. And despite the sharp drop in growth stocks over the past 12 months, investors who haven’t rebalanced for five years or more might still be a bit heavy on growth and light on value.

To keep your portfolio from drifting too far out of balance, it’s helpful to set a regular schedule for rebalancing. Morningstar’s previous research has found that while rebalancing too often can be counterproductive, either quarterly or annual rebalancing can help protect against downside risk while keeping volatility in check. A threshold rebalancing strategy—which involves setting 5% bands around each asset class’ starting portfolio weight and rebalancing whenever the weight moved at least 5 percentage points higher or lower than the target level—also made a significant positive impact.

Make Sure Your Portfolio Has Enough Bonds

This point is related to rebalancing, but also applies to investors who might have bailed out of bond funds after their recent losses. As we’ve written about previously, 2022′s bond market has been horrifically bad—by some reports, it’s the worst bond market ever. For the year to date through Dec. 20, 2022, the Morningstar US Core Bond Index is down more than 20%. As the Fed has repeatedly hiked interest rates to get inflation under control, long-term bonds have fared even worse: The Morningstar US 10+ Year Treasury Index is down more than 27% over the same period.

But most of the worst fixed-income damage has probably been done. At its most recent meeting in mid-December, the Fed raised its benchmark rate by 50 basis points, down from more aggressive hikes of 75 basis points at the four previous meetings. Not only is Fed easing off slightly on its hawkish monetary policy, but higher bond yields now provide more of a cushion against further losses even if rates continue trending up.

Most portfolios can benefit from at least a small allocation to fixed-income securities. This year’s turmoil notwithstanding, bonds typically serve as ballast during equity-market declines. And because bonds typically have a relatively low or negative correlation with stocks, they can help improve risk-adjusted returns at the portfolio level.

Don’t Give Up on International

It hasn’t been easy to invest outside the United States. As I discussed in a previous article, investors who own international stocks have been sorely tested. Although non-U. S. stocks have fared slightly better over the past few months, they’ve lagged by a wide margin for most of the previous decade. Non-U. S. stocks have suffered for three main reasons: the generally strong dollar; weaker earnings growth overseas; and a convergence in correlations between domestic and international stocks, which has reduced the diversification benefit from investing outside the U.S.

But giving up on international investing altogether probably isn’t a great idea. Non-U.S. stocks make up more than 40% of the global stock market, so investors who limit their portfolios to domestic issues would exclude a large chunk of the investable market. And while currency movements and stronger earnings growth have favored U.S. stocks recently, that won’t always be the case. Indeed, the U.S. dollar has trended down over the past few months. The increase in global correlations is more concerning, but it’s not clear whether correlations will remain permanently high. Allocating a portion of assets outside the U.S. should improve risk-adjusted returns if correlations trend back down.

Make Sure Your Portfolio Still Has Inflation Protection

Inflation has finally shown signs of easing up. For the 12-month period through November 2022, inflation rose 7.1% year over year, compared with 7.7% the previous month. Some of the underlying causes of inflation—such as supply chain issues—are also showing signs of normalizing. The market is currently pricing in a breakeven inflation rate of about 2.2% over the next 10 years, which would land below the 2.7% long-term average between 1920 and November 2022.

But as I’ve said before, inflation remains something investors should worry about. For one, it’s an insidious force that erodes value over time, even assuming a modest annual increase. This effect can be particularly destructive for retirees and other individuals living on a fixed income.

In addition, there is no guarantee that the Fed will be able to engineer a soft landing that brings inflation down to the 2% long-term target. Unemployment remains very low, some supply chain bottlenecks persist, and the war in Ukraine is likely to put pressure on food and energy prices in Europe. The historically high levels of government spending over the past few years—and the accompanying budget deficits—are another reason inflation could persist. Most investors will therefore probably want to maintain some level of inflation protection, such as Treasury Inflation-Protected Securities, I Bonds, or a small stake in commodities.

Don’t Give Up on Growth Stocks

Growth stocks have been particularly hard-hit in 2022′s market turmoil. As interest rates have climbed, investors have marked down the value of securities with cash flows far out into the future, including many of the large technology firms and other growth-oriented issues that previously led the market. At the same time, generally strong economic growth has shored up results for value-oriented sectors such as industrials and basic materials. As a result, the Morningstar US Value Index has lost less than 2% for the year to date through Dec. 20, 2022, while the Morningstar US Growth Index has shed more than a third of its value.

That’s a dramatic turnabout from the 10-year period ended in 2021, when growth stocks pulled ahead of their value brethren by more than 7 percentage points per year on average. But now that growth stocks have dropped from their previously lofty levels, their valuations are looking more reasonable. Growth stocks should also hold up better if the economy falls into a recession in 2023, as many investors now expect.

Consider Boosting Contributions to Your Retirement Plan

For U.S.-based investors, retirement-savings limits will be increasing by a healthy amount in 2023. For retirement savers under the age of 50, the contribution limit for 401(k)s, 401(b)s, and similar retirement savings vehicles will increase to $22,500 per year, up from $20,500 previously. People over the age of 50 can contribute an additional $7,500 per year, up from $6,500 previously.

Why should you consider funneling more savings into a tax-deferred retirement plan? For one, increasing your savings rate is one of the best ways to improve the odds that your retirement nest egg will be large enough to support a comfortable income during retirement. In addition, any contributions to a tax-deferred savings account directly reduce taxable income, which reduces taxes and frees up more cash flow for spending, paying down debt, or saving in a taxable account. Finally, valuations on both stocks and bonds have both significantly declined, which makes the long-term return prospects for retirement-plan contributions better than they were a year ago.