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Dos and Don'ts in a Volatile Market

Consider rebalancing and pulling forward IRA contributions, but don't get overexcited about buying opportunities or short-term market movements, says Morningstar's Christine Benz.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The New Year has brought a lot of volatility with it. I'm here with Christine Benz--she is our director of personal finance--for some dos and don'ts for investors during a volatile market.

Christine, thanks for joining me.

Christine Benz: Jeremy, great to be here.

Glaser: Your first "do" is that you should see if maybe it's time to rebalance--if rebalancing is in order. Why do you think a volatile market is a good time to think about rebalancing?

Benz: Well, I think a volatile market, first of all, is a good time to make sure you have some sort of asset-allocation framework that you are operating with because a lot of investors just sort of accumulate holdings without a lot of thought given to how much they should hold in stocks considering their life stage or how much they should hold in bonds given their life stage. To me, that's really the starting point.

If you don't have an asset-allocation framework--get one. And then assuming that you do have an asset-allocation blueprint that you're working with, I think it's a good time to look at whether some rebalancing might be in order. Despite a little bit of weakness in the market just over the past several months, we've had a very strong runup in stocks for six-plus years now--since early 2009. If investors have been very hands-off with their portfolios, they may, in fact, be a little bit heavy on stocks relative to their targets. So, it's a great idea to get in there and see where you stand today. I like  Morningstar's X-ray tool in terms of looking at the portfolio's total asset-class exposures. See where you stand relative to your targets. If you don't know where to get targets, I always say target-date funds can be a good way to see if you're in the right ballpark for someone within your age band. So, do that comparison.

For many investors, it may, in fact, be time to do some rebalancing, where you're peeling back on stocks and putting some money into bonds. Bonds don't seem especially attractive right now themselves, so I think investors want to be careful. They want to focus on, in my view, high-quality bonds. Even though high-yield bonds have sold off quite a bit recently, too, they tend to perform in sympathy with stocks. So, they won't provide as much diversification as high-quality bonds. So, investors who determine that they need bonds should focus on quality, and they should probably not, in my view, take a lot of interest-rate risk at this point in time. I think intermediate-term durations or perhaps short-term durations for money that they expect to spend within the next two to five years makes sense for investors' bond portfolios.


Glaser: The other item you think should be on investors' radar screens is IRA contribution season. Does it make sense to pull forward some of those contributions instead of waiting until the last minute in April?

Benz: Potentially--because we have had a little bit of weakness and, generally speaking, you want to try to put your money into the market when it's down a little bit. You have a few more months to make those IRA contributions for 2015--you have until mid-April this year to make those contributions. So, you can either get that money into the market straight away or you could perhaps set up a dollar-cost averaging program where, if you wanted to make your full IRA contribution, you could make fixed contributions over the next three months.

But I do think it's a decent time to think about funding those accounts. In general, taking control of your portfolio--thinking about things that you can control--is a really valuable thing to do amid volatile markets. So, if you can up your contributions or make new contributions, if you can focus on bringing down the costs of your total portfolio, improving the tax efficiency of your portfolio, those are all things that can help bring a sense of power back to investors at a time when things feel really uncertain and very unpredictable.

Glaser: One of the things you think investors shouldn't do is see this as an enormous buying opportunity. Why is that?

Benz: That's right--because, as we were discussing, stocks have enjoyed a very big runup over the past several years. Many market experts--yourself included--don't think that the market, as whole, is a screaming buy today. When we look at the price/fair value for all of the companies in our equity-analyst coverage universe today, they are trading at roughly a 7% discount to fair value. That's nowhere near as low as valuations got during the 2008 financial crisis, for example. I think some investors might naturally be attracted to some very beaten-down parts of the market--whether it's commodities or precious-metals equities or energy holdings or certainly emerging-markets stocks and bonds--but I think they should remember that there are some secular headwinds for all of those categories.

So, arguably, [those areas] are depressed for a reason right now. Certainly, investors will overshoot and oversell some of those areas of the market, and there may be buying opportunities. I know our analysts aim to flag those extremely mispriced companies when they become available. So, individual equity investors can certainly keep an eye out for those kinds of opportunities. People who are more hands-off with their portfolios, who maybe use mutual funds in lieu of individual stocks, should just make sure that they have a good value-oriented stock-picker on their side--someone who has been through a lot of different market environments and knows how to pick companies that could be due for a rebound.

Glaser: Finally, you say that you shouldn't make too much out of one or two really bad days in the market. But how do you tune out that noise?

Benz: I know. It's so platitudinous to tell investors that they should tune it out; but the fact is that, over time, investors do get paid for being willing to ride out these periods of market volatility that inevitability accompany stocks. One thing I think investors can perhaps take a sort of perverse sense of comfort in is the fact that given that starting bond yields are historically a pretty good predictor of returns from the asset class over the next decade, 2.5% yields or returns are just not going to cut it.

So, if you are an investor who needs growth in your portfolio, frankly you really have no choice but to be in stocks with at least a portion of your portfolio. So, I think that that should give investors some impetus to sit tight with their equity holdings--perhaps even add more. And I do think that taking advantage of all of those opportunities to regain some sense of control--whether it's additional contributions or doing a cost audit--all of those things can help empower investors in volatile markets.

Glaser: Christine, thank you so much for your thoughts today.

Benz: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.