February 03, 2022
The new year has been a rough one for stocks. And it hasn't been great for bonds either. Just about everything lost value in January.
So how you are feeling about what has happened?
The fact that your investments are down should not make you nervous or upset. If you are feeling either emotion that's a signal that you are not confident about your investment strategy.
Let's review a few things.
Investing in stocks is for long-term goals.
What stocks do on any given day, week, month, or year should not be your focus. Stocks are risky. There will be periods when they lose value. January is just the latest example.
If you have been watching your investments fall in value the past month or so, I am going to remind you to have some longer-term perspective. For every investment that is down year-to-date, please look at its performance over the past five years and 10 years.
For example, the S&P 500 index of large U.S. stocks was down more than 9% at one point in January. But for the past five years, the index has more than doubled in value. Over 10 years? A $10,000 investment in a low-cost index mutual fund or ETF that tracks the S&P 500 was worth more than $40,000 at the end of January.
Perspective is one of the best investing strategies.
A special note for those of you in your 20s, 30s, and 40s where retirement is multiple decades away: the decline in stock values can actually be good for you. Yes, you read that right. Now that stock prices are down, every dollar you invest can buy more shares. Over time - and you have decades - owning more shares that rise in value means having more money in retirement.
There are near-term problems with bonds.
It's one thing for stocks to lose value from time to time, but you may have core bond funds in your retirement accounts that also lost 1% to 2% in January. And that's surprising, right? Because bonds are supposed to be a buffer when stocks are falling.
The reason that bond funds lost value is because bond yields are rising from very low starting points. Long term that's a good thing, because more yield means more income. But as bond yields rise, their prices fall. A bond fund's total return is the combination of the yield plus any change in the price. Lately, that has netted out to a small loss.
Perspective is just as important here too. Over the long term, bonds do provide a valuable cushion.
But I have a huge caveat.
It matters a lot what type of bond funds you own. I have been advising you for years that if you invest in bond funds in your retirement account, stick with a core bond. Or if you were nervous about rising rates, invest in shorter-term funds, which don't react to rising rates as much as core bond funds.
We could see bond yields continue to rise in the coming months, as the markets (both stocks and bonds) react to changes in Federal Reserve policy. The Fed is going to raise its key interest rate soon and may continue to keep raising it in the coming months in an effort to put the brakes on the fast-rising inflation rate.
That doesn't make bonds bad. Again, a long-term perspective is important! But I want to repeat what I have been saying for years: short-term bond funds can make a lot of sense when interest rates are rising.
You need to evaluate your current mix of stocks and bonds.
I am all for being a patient long-term investor. But unless you are saving in a target date fund offered by a workplace retirement plan, you are in charge of rebalancing your portfolio from time to time.
Rebalancing is the official term for making sure your mix of stocks and bonds stays in line with your long-term asset allocation strategy. For example, if 10 years ago you decided on a mix of 70% stocks and 30% bonds, but you haven't rebalanced, your mix could be closer to 85% stocks and 15% bonds because stocks have done so well over the past 10 years. That's a lot riskier than the 70/30 mix you decided was right 10 years ago. And you're 10 years older? If you have aged from say 50 to 60, that's typically an age where you might want to slightly decrease the percentage of your overall portfolio you invest in stocks as retirement is nearer, not increase your exposure to stocks!
Rebalancing is not hard to do within your retirement accounts. You can log in to your account and exchange shares of stock funds for shares of bond funds. There is no tax bill when you do this inside a retirement account such as a 401(k) or an IRA.
Credit & Debt, Saving, Investing, Retirement