Key Takeaways:
- The first mistake is failing to rebalance. Investors should really take a look at their current portfolio’s asset allocation relative to whatever their target is for that asset allocation.
- Investors should put in place strategic inflation hedges, and don’t run to chase inflation-protective assets after inflation has already reared its head.
- The final mistake is mismanaging income-producing securities like lower-quality bonds.
Susan Dziubinski: I’m Susan Dziubinski with Morningstar. 2023 was a good year for most stock and bond investors, but investors might not experience the same smooth sailing in 2024. Joining me to discuss three key mistakes to avoid with your investment portfolio this year is Christine Benz. She’s Morningstar’s director of personal finance and retirement planning and the host of The Long View podcast. Good to see you, Christine.
Christine Benz: Good to see you, Susan.
Mistake Number One: Failing to Rebalance
Dziubinski: The first mistake you want to talk about relates to failing to rebalance. Why do you think rebalancing is especially important in 2024, and what should people be thinking about as they’re doing it?
Benz: Investors should really take a look at their current portfolio’s asset allocation relative to whatever their target is for that asset allocation. And I think if many investors go through that exercise today, what they’re likely to find is that their portfolio is perhaps heavier on U.S. stocks then would be their target, lighter on safer securities, and then they may also identify some intra-asset-allocation rebalancing areas, too. So we’ve had this long-running rally in U.S. growth stocks. Many portfolios are heavy on the growth side of the style box, light on value. Many portfolios are also light on non-U.S. stocks relative to U.S. So take a look at whether rebalancing is in order. Amy Arnott, our colleague, ran some research in late 2023 where she looked at portfolios five years ago if they had just been able to ride over the subsequent five years. She found that a 60/40 portfolio would be just 30% in fixed income today. So I think that’s particularly important for people who are getting closer to retirement.
Mistake Number Two: Adding Inflation Protection
Dziubinski: Now, you think another portfolio mistake that’s easy to make, frankly, especially today, is “back-burnering”—this idea of adding inflation protection to your portfolio because inflation seems to be coming down. Why is this a mistake?
Benz: I think it’s a mistake because we just keep going through these cycles where people are really reactive to inflation, where it’s like one day we care, one day we don’t care. My bias is just to put in place strategic inflation hedges, don’t run to chase inflation-protective assets after inflation has already reared its head. So if the period of 2021-2022 got you a little spooked about inflation and you didn’t do anything about it, even though inflation has ebbed away a little bit or normalized a little bit, I should say, it’s still a good time to think about adding Treasury Inflation-Protected Securities to your fixed-income portfolio, especially if you’re someone who’s already in drawdown mode. If you’re actively drawing upon that portfolio and you no longer have a paycheck to help keep you whole with inflation, I think you’d want to think about allocating a percentage of that fixed-income portfolio to TIPS. Roughly, I would say, 20%, 25% of that bond portfolio.
And then everyone, as a matter of course, should have equities in their portfolio because when we look at the asset class with the long-run ability to outrun inflation, well, stocks do that job for us. And then finally, Susan, I would say even though yields on very safe assets like CDs and money market accounts and funds are really attractive today, you want to be careful not to overallocate to those nominal bonds, nominal cash securities that do not give you any protection of your purchasing power. So that’s a caution there. I know investors have been very enthused about the very safe yields on offer today, but you can overdo it if inflation ticks up even a little bit.
Mistake Number Three: Mismanaging Income-Producing Securities
Dziubinski: Now, building on that a little bit, your final mistake we’ll talk about today regards mismanaging those income-producing securities, which you just alluded to. What do you mean by that?
Benz: I think there are a couple of risk factors for investors today that they should stay attuned to. One is that lower-quality bonds have had a phenomenal run, in part because we’re breathing a sigh of relief that we’re not in recession. I think many people thought in 2023 we would sink into some sort of weakening economy. We didn’t. And so we saw a very strong performance from the whole category of lower-quality bonds. So junk bonds, bank loans, emerging-markets bonds all had much better results than higher-quality fixed-income portfolios. I think the risk, though, is that you don’t want to overallocate to those types of securities, even though yields are tantalizing, returns have been great.
The risk is that if we do have another equity market shock, such bonds really are not protective. They’re not going to hold up as well as high-quality fixed income in those environments. Certainly in recessionary environments, low-quality bonds are not your friend. I would just say be careful there. If you’re adding lower-quality fixed-income securities, think of them as equity surrogates and maybe even take that chunk out of your equity allocation rather than thinking of it as a component of your fixed-income allocation. So that’s caution number one.
Caution number two is that, as we’ve seen, yields become much more attractive, so are the taxes associated with those higher-income streams going to take a bite out of your return. So just really be thoughtful about where you’re holding your fixed-income securities, where you’re holding your cash securities that are kicking off these nice yields. The concept of asset location is newly important in the face of higher yields. Now, for many of us from a practical standpoint, we do have income-producing securities in our taxable nonretirement account because we want to have access to the money. Well, in that case, if you’re a higher-income person, you’d want to think about potentially investigating municipal securities, both cash securities as well as bonds for that component of your portfolio in an effort to avoid federal income taxation on the income that’s coming off of those bonds and cash.
Dziubinski: Christine, thank you for your time today and for helping us hopefully skirt some of these mistakes in our portfolio this year. We appreciate it.
Benz: Thank you so much, Susan.
Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.
Watch “Retirees: Here’s What Your Portfolio Withdrawal Rate Should Be in 2024″ for more from Christine Benz.
The author or authors do not own shares in any securities mentioned in this article.Find out about Morningstar’s editorial policies.
