Morningstar's director of personal finance, Christine Benz, speaks on de-risking one's portfolio.
An extract from two conversations has been reproduced below: 4 ways to de-risk a portfolio in retirement and Reduce risk in your portfolio using a light touch.
The gold standard of de-risking is rebalancing.
There is a lot of confusion about what rebalancing does and doesn't do for your portfolio. Some investors assume that rebalancing must enhance returns. That’s not really what happens. When we look at some of the academic research that's been done on the virtues of rebalancing, most of it points to rebalancing being a risk-reduction tool.
The basic idea is that you are looking at your portfolio's asset exposures and you are taking them back to your target allocation. And this has the virtue of helping you sell your most appreciated positions and add what’s a bit depressed and maybe due for a comeback. So, academic literature points to rebalancing being valuable from the standpoint of risk reduction.
Your first tip to de-risk is to potentially cut back on stocks through rebalancing.
I sometimes wince when I hear people in the media advising investor not to do anything because the market is down. Well, guess what, a lot of people haven't been doing anything with their portfolios for 10 years. That means that they could in fact be heavier on equities relative to their life stage than they actually should be.
In a bull market, investors are pretty reticent to touch their portfolios, to sort of pull back on stocks when stocks have performed so well for so long. But an untouched portfolio is probably pretty heavily tilted toward stocks. So, if you were 60:40 (equity:debt) coming into a great rally, years down the road you could roughly be at 80:20, and you are many years older.
So, scaling back on stocks and putting some money into debt is much needed.
Rebalancing suggestions in drawdown mode
If you're in drawdown mode, one idea would be to think about spending from your most appreciated portions of your portfolio. That will probably be your equity holdings. Use those withdrawals to help meet your annual spending needs. This is a way that retirees can maybe psychologically cope with this idea of trimming back on the appreciated pieces of their portfolios.
Alternatively, you could spend the dividends that you receive instead of reinvesting them. Most want to reinvest their dividends and capital gains distributions. But withdrawing them can be a good way to at least not add more to those positions that have appreciated.
So, if you are in drawdown mode, this will give you a little bit more control over your withdrawals and helps keep you from plowing more money into securities that have already enjoyed a nice runup.
Wholesale de-risking of an entire portfolio is not advisable.
This is particularly relevant for investors far away from retirement. In fact, the younger you are, the more you should use the market dips as an opportunity to add more to stocks not less.
It does perhaps provide some short-term peace of mind if you are seeing the market drop a lot over a period of days or weeks. It can provide some short-term comfort to just get out of everything altogether, move everything to the safe investment on offer.
The key reason why you don't want to do that is that inevitably you will be stuck wondering when to get back in. Because the market often is streaky and will often log its best days on a series of short bursts as opposed to a slow, steady progression. That sort of relief can quickly be replaced with worry about, well, am I doing the right thing here and when is the best time to edge back into stocks.
Do read: Should you hold cash in your portfolio?
Take a fresh look at your equity portfolio.
On the equity side, if investors have been just kind of letting their winners ride, they will tend to have a concentration on growth stocks. If you are close to drawdown, think about giving your equity weighting a little bit more of a defensive cast. Stick to quality stocks. You might emphasize dividends a little more. Don’t exit equity altogether but give your portfolio a little bit more of a conservative bias.
Scout around your portfolio just to see if you are taking any big "dumb" risks in your portfolio--things like major style concentrations, major sector concentrations, major concentrations in individual holdings. Company stock is one that I would call out as something to avoid a big concentrated bet in, because so much of your individual wherewithal is riding on your company's fortunes. That's a place to look if you are attempting to reduce security-specific risk in your portfolio.
