Portfolio diversification can potentially help manage investment volatility over time. A custom, diversified portfolio, in line with your financial objectives and focused on long-term growth, can help improve your chances of achieving financial goals. While remaining invested in your target portfolio is typically enough to support your long-term investment success, there are effective strategies for navigating certain market conditions.
Strategies for a Bull Market
When stocks are increasing in value during a bull market, it may be tempting to chase returns. However, it’s important to remain focused on your long-term investment approach. The following asset allocation strategies can help maintain discipline during strong market performance.
• Rebalance your portfolio
As different asset classes experience varying growth rates, allocation drift can cause your portfolio to become misaligned with your risk profile and objectives. Rebalancing refers to selling off a portion of your high-performing assets and reinvesting the proceeds in lower-performing assets. While this may seem counterintuitive, it’s an important risk-management strategy because it helps prevent your portfolio from drifting too far from its target allocation (which can result in overexposure to market risk).
• Maintain liquid assets
During bull markets, hold enough cash to cover any emergencies and capitalize on market opportunities to buy low during an inevitable market correction. Maintaining liquid assets provides financial flexibility and positions you to take advantage of lower valuations when market downturns occur, enabling you to deploy capital strategically during periods of volatility.
• Incorporate value stocks
While growth stocks typically experience the strongest performance during bull markets, maintaining an allocation to value stocks has historically helped smooth out overall portfolio volatility. Bull markets often present an opportunity to purchase value stocks in well-established companies that are trading at a discount to their intrinsic value. Value investing complements growth stock exposure and helps create a more balanced portfolio.
Strategies for a Bear Market
During falling markets, diversification has historically played an even more important role in reducing portfolio volatility.
• Use dollar-cost averaging
Dollar-cost averaging refers to the process of investing money at regular intervals over a long period of time. This investment approach can help minimize the downside risk of making a single, large investment at an inopportune time. Bear markets represent an opportunity to continue purchasing stocks at a “discount” to their typical share price, allowing regular investors to pick up more shares when the price drops. By maintaining consistent investment contributions through various market cycles, you reduce the impact of market timing risk and benefit from purchasing shares at lower valuations.
• Employ tax-loss harvesting
Using a tax-loss harvesting strategy, you would sell an investment that has declined in value in the short term and replace it with a highly correlated alternative. When done correctly, this allows you to maintain your target risk profile and expected return while using up to $3,000 per year in investment losses to offset ordinary income. If you realize more than $3,000 of losses in a single year, you can carry over the excess amount to offset income in future years. Your realized investment loss can result in a tax deduction, and the tax savings can be reinvested to continue growing the value of your portfolio. This can be particularly valuable when done as a part of a direct indexing strategy.
• Add private investments
Private investments, such as private equity, private credit, private real estate and private infrastructure funds, have the potential to help reduce the portfolio risks typically associated with public markets. Private investments tend to have lower volatility than their public market counterparts, and they can serve as relatively non-correlated assets to add an additional source of diversification to the portfolios of qualified purchasers.
AJ Kratz, CFA, CFP, is a Private Wealth Manager and Partner with Creative Planning. Creative Planning is one of the nation’s largest registered investment advisory firms, providing comprehensive wealth management services to help align all elements of a client’s financial life, including investments, taxes, estate planning and risk management. For more information, or to request a free, no-obligation consultation, visit creativeplanning.com.
This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.