Pursue Growth in Today's Market
Jan 09, 2014
As equities continue to rise, more than ever they can play an essential role in helping you meet your goals
In the wake of the financial crisis five years ago, many people understandably shifted away from equities. In a "flight to safety," they switched to U.S. Treasury securities and other fixed-income holdings. Recently, as the economy began to show signs of a sustained recovery, the stock market rose to fresh highs. But many people remain reluctant to return to equities, concerned about taking on more risk.
Waiting on the sidelines can be risky, too. In recent months, interest rates have risen from their recent lows, and BofA Merrill Lynch Global Research now believes they will continue to rise gradually, although unevenly. (See "Preparing for Rising Interest Rates" sidebar.) As rising rates hurt bond values, equities may well be poised to continue their run. There's more to it than that, though. Equities have an essential role to play in most portfolios. "We believe virtually all investors need some exposure to stocks," says Cheryl Rowan, senior U.S. Equity Portfolio strategist at BofA Merrill Lynch Global Research and co-head of Merrill Lynch Wealth Management Investment Strategy. "We believe that, historically, there is no better asset than equities to build wealth over the long term. The key is to include them in your portfolio in a smart, risk-managed way."
Gauging Your Goals
To Rowan, the principal question isn't whether to buy stocks or even what stocks to own, but rather what you want to accomplish, in both the short and long term. "There are lots of potential ways to grow wealth," she says. "You need to start by reflecting on how you want to get there."
That includes factors such as when you’ll need money for particular objectives and your personal risk tolerance. Saving for your middle schooler's college tuition, for example, is different from accumulating assets for retirement—even if both are equally important to you. Because college is coming within several years, you may not want to take much risk with those assets, though you still need them to grow. For that portion, you might consider mature companies with fairly stable earnings that may provide consistent, if modest, growth. "They're not as exciting as some other companies, but that's not their job," Rowan says. "They provide stable revenues and earnings, and their stock prices tend to be less variable."
And while security is also important for your retirement income, the longer time frame gives you an opportunity to push for above-average returns. You might devote a portion of your stock allocation to more aggressive, concentrated holdings, keeping the rest of your retirement portfolio well balanced and diversified.
Especially with higher-risk holdings, it's important to manage risks appropriately, Rowan says. "One way to do that is to include stocks of companies that are not highly correlated with one another," she explains. "You don’t want all of the stocks or funds in your portfolio to be affected by the same economic and market dynamics. When everything is going up together, you'll be very happy, but then there will be a day when you’ll be very sad."
Rowan notes that some sectors, seemingly distinct from each other, can in fact be tied to similar market conditions. As an example, take financial stocks and the consumer discretionary sector. "They seem completely different, but they're both dependent on the supply and price of credit," Rowan says. "When interest rates rise, that's a negative for both sectors."
Achieving broad diversification may well require venturing into areas of the market that are unfamiliar to you. Industrials and energy, for instance, are two sectors largely unknown to most investors. "If you talk about a big discount retailer, everyone understands what it is, what it does and how it makes money," she says. "Getting a handle on companies that make roller bearings or aircraft engines is more challenging."
Keeping your portfolio well diversified also means not abandoning bonds, even with their still-low present yields. "It pays to have some high-quality fixed-income securities, because that will protect you from any surprises that might lie ahead," says Marty Mauro, fixed-income strategist at BofA Merrill Lynch Global Research and co-head of Merrill Lynch Wealth Management Investment Strategy.
In addition, managing your portfolio risk means revisiting your strategy frequently—probably at least twice a year, and maybe more often. Doing so can help you make sure your overall asset allocation, as well as your specific equity and bond holdings, is still aligned with your individual goals. As Rowan observes, "When markets turn volatile, allocations need to be adjusted. In reviewing your holdings, look at how prices in the market may have affected the weighting of various assets in your portfolio."
Say, for instance, that you have a higher-risk security accounting for 3% of your original portfolio. If it grows quickly, it could soon make up as much as 8% or 9% of your holdings, creating an imbalance—and increasing your risk if the security suddenly begins to lose value. You might consider paring back an investment like this, selling all or a portion of it when prices are relatively high and using the proceeds to bolster your portfolio in other ways.
Another reason to review your strategy regularly is to confirm that it's still lined up with your goals. As you move closer to specific events, you may well want to be more conservatively invested. And because life goals change just as markets do, tell your financial advisor about any significant changes in your situation or your financial objectives. That way, you can see to it that your money is always helping you pursue what matters most to you—allowing you to concentrate on the aspects of your financial life that you can control.
As Rowan puts it, "When you have your goals clearly stated and you design a portfolio to achieve those goals, it's much easier to stay focused."
SOURCE: Unless otherwise indicated, statistics in these stories come from BofA Merrill Lynch Global Research.
ABOUT FIXED-INCOME SECURITIES: Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa. Investments in high-yield bonds (sometimes referred to as "junk bonds") offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a junk bond issuer's ability to make principal and interest payments. U.S. Treasury Inflation-Protected Securities (TIPS) are subject to interest rate risk. If interest rates rise, the market value of your Treasury investment will decline. While you may be able to liquidate your investment in the secondary market, you may receive less than the face value of your investment. As with other securities, the market prices of U.S. Treasury inflation-indexed securities will be subject to the then-prevailing market conditions. Companies may reduce or eliminate dividend payment to shareholders. Historically, dividends make up a large percentage of stocks' total return.
ABOUT EQUITIES: Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Stocks of small-cap companies pose special risks, including possible illiquidity and greater price volatility than stocks of larger, more established companies.