The stock market is at an all-time high and I am worried about the stock market declining from here. Should I reduce my stock allocation?

I am worried about how low interest rates are and whether bonds make sense to keep in my portfolio. As a result, should I increase my stock allocation?

These are real and justifiable questions. Our response, however, cannot be simplified into a yes or no answer. The decision to change your allocation needs to be based on your own specific situation rather than media headlines or shorter-term market trends. Changing the allocation to stocks could actually be the right move for both of these hypothetical investors. However, this decision should have less to do with recent market performance or what “could” happen in the financial markets.

Determining Your Portfolio’s Allocation

Choosing the right allocation (ratio of stocks/bonds/alternatives) is the most important decision an investor will make. The decision must have the right balance between earning enough return to meet your financial goals while only taking on only as much risk as you can tolerate. If you take on too much risk, you might not be able to stick with the portfolio through challenging markets, and if you don’t earn enough return, you may not meet your goals.

Focus on What You Can Control

We have no control over short-term market movements, and we have no say over the headlines that threaten to distract investors. It does not make sense to change an allocation in response to the big gains investors have seen since the market bottomed in March of 2020, nor does it make sense to shift an allocation based on how the bond market is reacting to the Federal Reserve’s recent statements. Too often, individual investors get distracted and focus on past returns rather than staying focused on the desired end goal.

As a result, many investors are disappointed by poor timing decisions or let down by the performance of the stock that was touted on social media or TV last month. As we have always advised, Savant is focused on what we can control and what the market fundamentals are.

The Downfalls of Investor Behavior

To highlight how emotion and fear influence many investors, we can look at the Quantitative Analysis of Investor Behavior (QAIB), a research study by Dalbar. In a mid-year update of the QAIB study, Dalbar found that the gap between the average equity fund investor and the U.S. equity market had widened considerably in the first half of 2021. The study previously found that investors mitigated their losses during the volatility that followed the emergence of the pandemic in 2020. For the year 2020, the investor gap for equity investors was 1.11% (17.29% for the average equity fund investor and 18.40% for the S&P 500). While this is a material underperformance, it was not alarming based on historical comparisons. However, equity fund investors did divest during 2020 and continued to do so into 2021. Many investors reacted to the headlines and in an attempt to time the market moved their money in and out of the market at the wrong times.

When Should You Change Your Allocation?

Reasons to Consider Reducing Stocks

  • Major change in lifestyle or health
  • Decrease in earned income
  • Significant new anticipated short-term expense
  • Willingness and ability to earn lower returns over lifespan without running out of money
  • Decide to spend kids’ inheritance in exchange for sleeping better at night (less volatility)
  • Expect future inheritance or other influx of cash (thus, you can afford lower returns)

Reasons to Consider Increasing Stocks

  • Potential for a higher return to achieve financial independence
  • Financial literacy and experience made you more confident and comfortable with risk
  • As you age, realizing that many of your assets will likely pass to family or a charity
  • Determining that you have more than enough assets and can afford more equity risk
  • Potential for higher return to offset principal erosion from inflation and tax
  • A long lifespan (family longevity), requiring your portfolio to last longer
  • Desire to rely less on long-term solubility of Social Security
  • Anticipating a future inheritance or influx of cash (thus, you can afford more risk)

You should strike the right balance between earning enough return to meet your goals and taking the right amount of risk that you can personally tolerate so you can sleep at night.

Because determining an appropriate allocation is so important, it often helps to ask your financial advisor to weigh in on this decision. Working with a professional can also help you stay disciplined and focused to consistently stay on course to make progress toward your goals.

This is intended for informational purposes only and should not be construed as personalized investment or financial advice. Please consult your investment and financial professional(s) regarding your unique situation.

About Savant Wealth Management

Savant Wealth Management is a leading independent, nationally recognized, fee-only firm serving clients for over 30 years. As a trusted advisor, Savant Wealth Management offers investment management, financial planning, retirement plan and family office services to financially established individuals and institutions. Savant also offers corporate accounting, tax preparation, payroll and consulting through its affiliate, Savant Tax & Consulting.

©2023 Savant Capital, LLC dba Savant Wealth Management. All rights reserved.

Savant Wealth Management (“Savant”) is an SEC registered investment adviser headquartered in Rockford, Illinois. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments and/or investment strategies recommended and/or undertaken by Savant, or any non-investment related services, will be profitable, equal any historical performance levels, be suitable for your portfolio or individual situation, or prove successful. Please see our Important Disclosures.