Portfolio Strategies for a Shaky Market
As retirement nears, avoiding major losses is essential
But if you're routinely selling winning stocks to reset your asset allocation, won't you lose out on gains? In the short run, probably yes. But over time, investors who rebalance give up very little in returns—and enjoy a much smoother ride.
T. Rowe Price recently crunched some numbers and found that a 60-30-10 mix, left unrebalanced, would have returned 11.1 percent a year from the end of 1984 through June 2007. But if you had rebalanced your portfolio back to that 60-30-10 mix every time your stock allocation rose or fell by more than 5 percentage points, your returns would have been nearly the same: 10.9 percent annualized. But your portfolio would have been 18 percent less volatile.
Yet less than 1 in 5 retirement investors rebalanced 401(k) accounts last year, according to Hewitt Associates, an employee benefit research firm. "Rebalancing is sort of like the flossing of investing," says Barry Glassman, a financial planner in McLean, Va. "It's so important, yet not that many people do it enough."
Change the types of stocks you own, not the amount. Afraid to reduce your exposure to stocks because you're worried you might outlive your nest egg? Here's an easy fix: Change the types of stocks you own to a safer mix.
For example, when the market averages are bouncing around wildly from day to day, as they have in recent months, strategists recommend that investors stick with shares of large, industry-leading companies. The stocks of big companies not only have trailed the broad market in this decade (which means they have less room to fall), but they also tend to sway less than shares of fast-growing, small companies.
The worst three-month loss for small-cap stock funds in the past decade was 25.3 percent in 1998, according to the fund tracker Morningstar. But funds that invest in large, blue-chip stocks dropped no more than 16.7 percent, in 2002.
Another option is to hold stocks that pay out dividends. That income offers you some cushion against losses when stock prices tumble. In the recent sell-off, the WisdomTree LargeCap Dividend fund didn't escape declines. But it beat the S&P 500 by 1.4 percentage points over the past month.
Don't slam on the brakes too hard. If you find that a stock sell-off is so unnerving that you lose beauty sleep, you can cut back on stocks. But don't go overboard. "You don't have to go entirely to cash," Scarborough says. "Just back your portfolio off a little."
Even just tweaking your asset allocation might be enough to ease your jitters. The Vanguard Group compiled data on asset allocation strategies going back to 1926. It found that a portfolio consisting of 60 percent stocks and 40 percent bonds produced an average annual return of 8.9 percent. But this portfolio lost money in 20 calendar years between 1926 and 2006—diving nearly 27 percent in its worst year, 1931.
By downshifting slightly, to a 50-50 stock-bond mix, you'd have earned nearly as much: 8.5 percent a year. Yet you would have lost money in only 16 calendar years, and your worst yearly decline would have been 22.5 percent, again in 1931.
Whichever strategy you choose, the key for older boomers is to do the little things now that will prevent larger losses once in retirement. As people live longer, retirement may turn out to be an extended journey, but the last thing you want to do, Cook says, "is dig yourself a big hole that makes it difficult to come back from."