Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. With volatility in the stock market dominating the headlines again, many investors might be wondering if they can or if they should reduce risk in their portfolio. I'm here with Christine Benz, she is our director of personal finance. We are going to take a closer look at four light ways to reduce risk.
Christine, thanks for joining me.
Christine Benz: Jeremy, it's great to be here.
Glaser: Maybe we should start with what generally isn't advisable, and that's just a wholesale de-risking of an entire portfolio, particularly for investors that are far away from retirement.
Benz: Yeah, that is not a strategy I would advise. It does perhaps provide some short-term peace of mind if you are seeing the market drop a lot over a period of days or weeks. It can provide some short-term comfort to just get out of everything altogether, move everything to the safe investment on offer in your investment program.
The key reason why you don't want to do that is that inevitably you will be stuck wondering when do I get back in. Because the market often is streaky and will often log its best days on a series of short bursts as opposed to a slow, steady progression. That sort of relief can quickly be replaced with worry about, well, am I doing the right thing here and when is the best time to edge back into stocks.
Glaser: Your first tip for a light way to de-risk is to potentially cut back on stocks through rebalancing, that this is a great time to look at your asset allocation.
Benz: Absolutely. And you know, I sometimes wince when I hear people on TV or in other places saying nobody do anything, the market is down. Well, guess what, a lot of people haven't been doing anything with their portfolios for 10 years. That means that they could in fact be heavier on equities relative to their life stage than they actually should be if they have just been letting their winners ride.
So, even if you haven't done anything and your portfolio balance has been sinking lower and your equity holdings have been sinking lower, it's still maybe the right call to de-risk that portfolio a little bit, to take some money off the table in stocks and move it into bonds or perhaps cash. That will tend to be less advisable, the younger you are, the more you should use the market dips as an opportunity to add more to stocks not less. But for people who are getting close to retirement, people who are 50 and above, absolutely, they should use our X-Ray functionality, see where they are now, compare it to a target, and see if some de-risking is in order.
Glaser: Within asset classes, too, your second tip is to maybe think about being in more defensive sectors or in more defensive bond funds.
Benz: Absolutely. Because again, if investors have been just kind of letting their winners ride, they will tend to have a concentration in the growth side of the style box, even though that's been the epicenter of the recent market weakness. In fact, some of the portfolios that I've been working on in our portfolio makeover series have been very heavy on growth stocks. So, check that out.
Think about especially again if you are someone who is getting close to drawdown, getting close to retirement, think about giving your portfolio equity weighting a little bit more of a defensive cast. You might emphasize quality more. If you are an individual stock picker, you might focus on what we call wide-moat companies. You might emphasize dividends a little more. You might also invest in some sort of a product that focuses on the subset of stocks that we classify as low volatility or that index providers classify as low volatility. Those are ways to stay in equities, but give your portfolio a little bit more of a conservative bias.
You can do the same on the bond side, where you might have in your portfolio some lower quality bond holdings, maybe some more income-focused bond holdings. If you are concerned about volatility related to the equity market, make sure that your bond holdings are really ballast for you, that they are going to deliver for you on days when the equity market sells off. That's generally high-quality bonds. Long duration bonds often perform best on big equity market down days. But I think for investors who are looking for a low-risk bond portfolio, they would probably want to focus on short and intermediate-duration bonds.
Glaser: You say this is a time to potentially reduce idiosyncratic risk. What do you mean by that?
Benz: I think that's a great thing to do at times like these. Scout around your portfolio just to see if you are taking any big "dumb" risks in your portfolio--things like major style concentrations, major sector concentrations, major concentrations in individual holdings. Company stock is one that I would call out as something to avoid a big concentrated bet in, because so much of your individual wherewithal is riding on your company's fortunes. That's a place to look if you are attempting to reduce security-specific risk in your portfolio.
Glaser: Finally, you think this could be a good time to review your portfolio maintenance regimen. Why is that?
Benz: Well, I would say, for people who have specific holdings that are causing them a lot of angst, there are maybe some tweaks that you could make without completely upending your plan to reduce your exposure to those very volatile positions. For people who are making additional ongoing contributions, say, through a 401(k) plan, maybe you just reduce your future contributions to those holdings, not your contributions overall, but to those problematic holdings. That would be one way to maybe buy yourself a little peace of mind.
Another idea is, if you are kind of in maintenance mode with your portfolio, where you are neither adding to it or withdrawing from it necessarily, reinvesting the dividends and capital gains distributions--a lot of us have those boxes checked with our fund providers--maybe uncheck them for the holdings that are again causing you the most angst and causing the most volatility in your portfolio. You are not bailing out of them altogether, but you are just saying, well, for now at least, I'm not going to commit additional capital.
And finally, for retirees, I do think that they have an opportunity if they have holdings that they found especially problematic to tie their scaling back on those positions in with whatever withdrawal system they are using. If they are pulling from their portfolio anyway, why not pull from those holdings that are causing them a lot of angst. Those are some easy ways to reduce exposure to positions without getting out of those positions altogether.
Glaser: Christine, thank you.
Benz: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.