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  • Doug Oosterhart, CFP®

When the Market Is Up but Feels Like It’s Down

The year 2023 has painted a perplexing picture for investors. At a glance, the stock market is up year-to-date (and as of this writing), showcasing its resilience in turbulent times. However, if you're an investor with a balanced portfolio -- aka all investors that don't hold 100% stocks -- you might be scratching your head and wondering why your portfolio doesn't mirror the market's optimism. The culprit? Rising interest rates and their cascading effects on bond prices.

The Bond Conundrum

Historically, bonds have been viewed as the "safe" option, the bedrock of stability for risk-averse investors. But it's crucial to note that "safe" doesn't always equate to "risk-free." Bonds are historically less volatile than stocks, but they aren't immune to the economic forces that can send their prices tumbling.

When interest rates rise, bond prices tend to decrease, which we have seen over the past 18 months. This inverse relationship stems from the fact that new bonds issued at higher rates make existing, lower-yielding bonds less attractive. Thus, their prices drop. For investors, this means the value of bond funds takes a hit. In a balanced portfolio, where bonds play a pivotal role, this decline can be distressing.

On top of that, longer-term bonds are more sensitive to rate changes. For example, TLT, which tracks 20+ year treasuries is down 40% since the beginning of 2022 whereas SHY, which tracks 1-3 year treasuries is "only" down about 2%. As one can see, it's important to know what type of bonds are being held in a portfolio and the potential risks to them.

A Misplaced Sense of Safety?

The perception of bonds as a "safe haven" adds to the current conundrum. Many investors are shaken, not just because of the declining bond prices, but because their safety net seems to have frayed. This underscores the importance of understanding investment vehicles and not just relying on historical precedents.

While bonds have been less volatile than stocks, they are still susceptible to market shifts. Investors who approached bonds with the mindset of unshakeable stability are now facing the realities of market dynamics.

Portfolio Construction in the Current Climate

The financial environment of 2023 is a stark contrast to what we experienced just two years ago. Portfolio construction, now more than ever, is not just about diversification; it's about strategic diversification and making sure that each dollar has a specific goal.

Balancing between stocks, bonds, and other assets has always been the cornerstone of a solid investment strategy. But with the changing dynamics, it's essential to reassess and possibly reconfigure your portfolio based on the current market environment and future predictions.

Investors might consider

Reevaluating their non-stock allocation: Given the volatility in bond prices, it might be time to reconsider your non-stock allocation. Some alternatives might include CDs, Multi-Year Guaranteed Annuities (currently, there are MYGA's paying more than 6% guaranteed), defined outcome (buffered) ETFs, bond ladders at higher rates, and more.

Staying Informed the right way: The best financial reporting is interesting, but too many in the financial media try to make ALL news "actionable." It's important to make the distinction between the signal vs. the noise.

Not getting caught making predictions: The market's greatest trick is convincing you it's predictable in the short term.

Timeline matching your investments: Assign "use-by" dates for each dollar of the portfolio. Dollars with shorter timelines will be invested differently than dollars with long timelines. It might sound simple, but it's instrumental in portfolio construction.

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