Stocks are down. Bonds are down. Market volatility is high. We are all feeling a bit frustrated with our investments this year and wondering if we need to overhaul our portfolio. Part of this is also deciding which financial instruments are best suited to your personal situation.
According to Christine Benz, Morningstar’s director of personal finance and retirement planning, “It’s generally not a good idea to think about a major portfolio shake-up in the midst of market volatility.” She would not recommend market movements as the catalyst for an investment decision, as emotions are often involved.
But if you decide it’s the right time for you to make major changes to your portfolio, what should you do to make sure you choose the right products? We have some ideas.
First, do your due diligence
Before you even think about what to buy, it is essential that you understand the Why behind this decision. Here are four steps you shouldn’t overlook:
- Step 1: Take a holistic view of your goal.
- Step 2: Determine your risk tolerance, then choose the types of investments that match it.
- Step 3: Commit to a timeline. This will give your money time to grow and compound.
- Step 4: Stick to your plan and just do your annual checkup or quarterly checkup or whatever works best for you and your situation.
To help understand why these steps are so important, let’s look at two diametrically opposed scenarios where you’ll need to make a decision about which financial instruments to buy.
Scenario 1: How to select the right investments for short-term goals
Anytime you’re saving for a short-term goal, it’s worth spending a few moments anchoring your decision-making in the numbers. It helps to answer a few questions about this, including:
- How likely are you to achieve your financial goals given your investment mix?,
- How much have you saved so far?
- How many additional contributions will you make per month?
- How many years do you have to save and invest?
Once you’ve answered these questions, finding the right investment mix will also depend on your own risk capacity, risk tolerance, flexibility with your goal, and willingness to increase your own rate of return. savings if it means greater peace of mind. disturbs.
According to Benz, if you’re planning to buy a home in the next five years and don’t want to risk having your investments bottom out when you need the cash, you can opt for a more conservative asset mix, even if it reduces the likelihood of you winning much more than your target amount. If, on the other hand, you’re willing to delay your home purchase date if it gives you a chance to amass a larger down payment, you can change the asset allocation to make it slightly more aggressive. .
However, Benz suggests not going overboard with stocks, as the portfolio should be subject to greater short-term fluctuations than is ideal.
By selecting investments for short-term goals, you can seek out cash instruments and money market funds with attractive yields. When it comes to fixed income securities, you have to take into account that long-term bonds are more affected by rising interest rates than short-term ones. Finally, “as long as you hold a portion of your portfolio short-term in equities — and that’s optional, especially for conservative types — focus on high-quality, large-cap funds,” says Benz.
Scenario 2: Choosing the right investments for retirement
Figuring out how much you’ll need in retirement is one of the most common — and biggest — financial challenges faced by those of us who are still working. It is a calculation that involves many variablessome under your control, some not.
Some factors to consider include:
- Your income replacement rate
- Your retirement age
- Your life expectancy
- Your savings rate
- Your withdrawal rate (the percentage of your savings you must use each year in retirement) and
- What public pension (if any) you might be entitled to
“Retirement requires seeing if you have enough to sustain yourself over your time horizon,” Benz says. And then from there you can look at the positioning of the portfolio and the selection of financial instruments.
The level of volatility you are comfortable with is a key factor when selecting holdings for your portfolio.
If you’ve reacted badly to market volatility in years past — selling positions when they were in a dip, for example — you might want to emphasize downside protection.
“The main way to reduce the level of volatility in your portfolio is to adjust its asset allocation, but you can also reduce the ups and downs of your portfolio by focusing on investments that take a risk-conscious approach to a given asset class,” says Benz. “When assigning Morningstar Medalist ratings, Morningstar analysts take into account the funds’ attention to downside protection.”
If you know you can handle higher volatility if the prospect of higher returns attaches to it, you might consider gearing your portfolio towards the aggressive, with more emphasis on investments that have the potential to higher returns over the long term, even if they come with higher volatility.
Don’t forget the fees, which could eat away at massive chunks of your pot
To finish, don’t forget to look at the costsbecause high fees kill performance.
Morningstar Research has shown that fees are a reliable predictor of future returns. Low-cost funds are generally more likely to survive and outperform their more expensive counterparts. This is because fees accumulate over time and reduce returns. Expenses are also one of the easiest factors for mutual fund investors to control. You can’t be sure how a fund is performing, but you can know exactly how much you’re paying for it.