Becoming an Investor

Tune Up Your Stock Portfolio for 2022

The outperformance of stocks in 2021 might leave you a bit more exposed than you should be. The end of the year is a great time to rebalance.

Thanks to a bull market in stocks that has stretched deep into its second year, stocks have trounced bonds since March 2020, when the relentless climb began. As of early October, the S&P 500 index has more than doubled, compared with a 4.2% return for U.S. bonds, as measured by the Bloomberg U.S. Aggregate Bond index. But there’s a potential downside to the big rally: Many investors might be holding a bigger stake in stocks than their risk tolerance calls for. And that could make portfolios more vulnerable to a stock market downdraft.

There’s an easy fix: Rebalance your portfolio to get your asset weightings back in line with your desired allocation. “Rebalancing prevents you from taking unintended risks,” says Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

Start by tallying up the total dollar value of the stocks, bonds and cash you hold in your taxable and retirement accounts. If you own a fund that invests in both stocks and bonds, such as a balanced fund or target-date fund, review the fund’s latest holdings to see how much it holds in each major asset class. To find out your current asset mix, calculate the percentage of each asset class relative to your total portfolio. For example, if you have a $1 million portfolio and $750,000 is now held in stocks, your equity stake is 75%.

A portfolio that started out in March 2020 with 60% stocks and 40% bonds now is closer to 75% stocks. Trim stock holdings that have gone up in value the most and funnel the proceeds into bonds or cash to get your portfolio back to your target weightings. To minimize your tax bill for sales in taxable accounts, consider offsetting gains by lightening up on losers.

Take Advantage of Volatility

A relatively calm 2021 stock market turned volatile in a big way this fall, with a number of nail-biting days. When stock prices bounce around, dollar-cost averaging, a strategy that involves investing a set amount at periodic intervals, helps in two ways. First, it lowers your average cost per share because you buy more shares when they are cheaper. Second, it takes the emotion out of investing—a challenge when volatility dominates the headlines.

Say you put $1,000 per month into a stock that starts out at $25 a share, then dips to $12.50 the next month before jumping back to $20 and then to $30 in months three and four. After four months you’d own 203 shares at an average cost of $19.70 each. Had you invested the whole $4,000 at once, you’d have paid $25 a share for 160 shares. Perhaps more important, committing to automatic monthly installments would have kept you from second-guessing yourself when the stock hit a low ebb.

Prepare for Higher Interest Rates

Rock-bottom interest rates have been a fixture of the fixed-income market for years. But a gradual liftoff is under way. The Federal Reserve has signaled it will begin to reduce its purchases of Treasury and mortgage-backed bonds, and it could start hiking its benchmark short-term rate in 2022. “My guess is one rate hike at the end of 2022 and three rate hikes for 2023,” says David Kelly, chief global strategist at J.P. Morgan Asset Management.

Long-term rates, more responsive to expectations for strong economic growth and rising inflation, are already higher, with 10-year Treasuries yielding 1.6% in early October, up from less than 1% at the start of 2021. “Yields will move higher, irregularly and over time,” says Bob Doll, chief investment officer at Crossmark Global Investments. “The pattern we’ve seen so far is two steps up, one step back, then two steps up.”

Because bond prices dip when rates are rising, income investors face a challenge. With Treasury bonds, choose short maturities, which are less sensitive to rate swings. Or stick with assets that hold up relatively well in a rising-rate environment. Doll likes Treasury inflation-protected securities, which you can purchase directly from Uncle Sam at www.treasurydirect.gov or via a low-cost fund such as Schwab U.S. TIPS ETF (symbol SCHP, $63).

Other options include floating-rate notes (bank loans with interest rates that reset higher when market rates rise) or high-yield corporate bonds. These are riskier IOUs. The team at T. Rowe Price Floating Rate (PRFRX) is top-notch; Vanguard High-Yield Corporate (VWEHX) takes a cautious approach. Hybrid securities, sharing character­istics of both stocks and bonds, are worth a look now. Consider Virtus InfraCap U.S. Preferred Stock ETF (PFFA, $25). For more on preferreds, see Income Investing.

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