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Rebalance to Help Manage Risk

Wells Fargo Investment Institute - March 2018

Transcript: A Time to Rebalance

Is your investment risk tolerance the same today as it was 20 years ago? How about your return expectations? Maybe they are, but probably they’re not.
Let’s say you’re 55 years old now, and hopefully much closer to realizing your financial goals than when you were 35.
It’s probably reasonable to assume that your profile has changed over the years as your savings and investments have increased.
That, along with fewer years to retirement, may have changed the way you look at risk as well. One thing is for sure: as we go through life, change is inevitable.
So, when it comes to investing, we need to make sure our plans are adjusted to match our changing needs and circumstances. And that’s called portfolio rebalancing.
For instance, if you have 20 years to retirement, you may choose a riskier mix of stocks and bonds, since you may have time to make up for any losses.
But, if your goal is just around the corner (like buying your dream house or making that first college tuition payment), you may want to choose a very different mix of investments for your portfolio—one that tries to limit short-term risk.
Rebalancing may cause your portfolio to shift toward a more aggressive allocation, or a more conservative allocation. But, either way, your plan and your portfolio need to be dynamic and current—and that may mean regular rebalancing.
So, whether you’re 35, 55, or even 75, taking the time to adjust your portfolio by rebalancing is always a good idea. Your long-term financial success may even depend on it.

If you’re ready to find out more about rebalancing your investments, talk to your Financial Advisor, or call 866-224-5708.
Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.
Wells Fargo Investment Institute, Inc., is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.
Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company.

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Since 1988, the market has averaged a 3% pullback every 14 trading days. Given such an extended rally, investors’ equity allocations may have grown disproportionately large. If that is the case, then a correction may erase more of an investment portfolio’s value than investors may be expecting. We recommend investors be prepared for a potential pullback by holding a diversified portfolio and making sure that current allocations correspond with their original investment plan. It may be time to rebalance.

Strong performance in equity markets could have increased risk in your portfolio

The current equity-market recovery has surpassed the return and duration of the average bull market.

Strong Performance in Equity Markets Could Have Increased Risk in Your Portfolio 

Sources: Bloomberg, Factset and Wells Fargo Investment Institute, as of March 6, 2018. For illustrative purposes only.
The market is represented by the S&P 500 Index. Index returns reflect general market results, do not reflect actual portfolio returns or the experience of any investor, nor do they reflect the impact of any fees, expenses or taxes applicable to an actual investment. The S&P 500 Index is a market-capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the U.S. stock market. Past performance is no guarantee of future results. An index is unmanaged and not available for direct investment.

Our Outlook for the Rest of 2018

What We Expect

  • Stock prices should continue to rise through 2018, although higher interest rates could be a near-term headwind. 
  • Modest inflation should gradually lift bond yields but weigh on bond prices.
  • Notwithstanding the expected benefit to U.S. markets in 2018 from the new tax legislation, global diversification will likely be increasingly important as the U.S. moves further along in its economic recovery than international markets.

Actions to Take Now

  • Evaluate how hypothetical portfolio allocations might have performed during past crisis events. 
  • Make sure your plan and current asset allocation are aligned with your risk and return expectations.
  • Consider using excess cash to bring your current portfolio allocations into alignment with your plan’s targets.

Make sure your portfolio is aligned with your investment goals

2017 was a great year for global stocks. Bonds, public real estate, and many hedge funds also posted positive returns. Following an unusually broad-based market rally, the way a portfolio is allocated can shift dramatically, sometimes without the investor’s knowledge. As a result, we recommend investors regularly identify the risks in their portfolios in case of a market downturn. An evaluation of hypothetical historical investment performance is a good way to see how a portfolio allocation may have performed in past crisis events. A portfolio that has more risky assets like equities tends to rise more in positive markets and suffer greater losses in negative markets. The chart below shows that during certain historical crisis events, growth portfolios declined the most, income portfolios tended to decline the least, and growth and income portfolios experienced moderate declines.

Performance of model portfolios against historical events

Portfolio Drift During the Bull Market (March 2009–December 2016)

Sources: Wells Fargo Investment Institute and Morningstar Direct. Cumulative returns for the time periods noted as of September 30, 2017. 

Performance results for the model portfolios are hypothetical and for illustrative purposes only. The indices reflect the historical performance of the represented assets and assume the reinvestment of dividends and other distributions. An index is unmanaged and not available for direct investment. Index returns reflect general market results and do not reflect actual portfolio returns; the experience of any investor; or the impact of any fees, expenses, or taxes applicable to an actual investment. Hypothetical and past performance does not guarantee future results. 

Keep in mind, there are difficulties in assessing hypothetical asset-class performance during certain crisis periods, in part, because these results do not represent actual trading and cannot completely account for the impact financial risk has on actual trading. In addition, any actual portfolio or account will invest in different economic conditions during periods with different volatility and in different securities than those incorporated in the hypothetical performance shown above. It is possible there are other scenarios or crisis events that could have resulted in heavier losses for a portfolio than those that occurred during the time periods shown. There is no guarantee any asset class will perform in a similar manner in the future. Please see the end of this report for the model portfolio compostions, definitions of the indices, and risks associated with the representative asset classes.

Consider rebalancing now to help manage risk

If you find your portfolio has shifted away from your desired asset allocation, we recommend you consider rebalancing. This means selling investments from allocations that have outgrown their targeted portion of your portfolio and using the proceeds to purchase investments that are underallocated in comparison with your target. For example, if a targeted 60% stock/40% bond portfolio is now at 75% stocks/25% bonds, you may want to sell stocks and buy bonds. While rebalancing might reduce your portfolio’s upside potential in the near term, it also can lessen the possible downside when a market correction occurs, potentially enhancing your longer-term returns (see chart below). 

Rebalancing is advisable when there has been market activity like we’ve seen during the past few years. We recommend rebalancing at least annually as a standard practice to help manage risk and return on an ongoing basis.

Hypothetical benefits of diversification and rebalancing

Reduce Certain Riskier Asset Classes 

Sources: Morningstar Direct and Wells Fargo Investment Institute; as of November 30, 2017. Performance results for the Moderate Growth and Income Four Asset Group portfolio without private capital (PC); and 60% S&P 500 Total Return Index, 40% Bloomberg Barclays Aggregate Index portfolios are hypothetical and are presented for illustrative purposes only. 

Performance results for the Four Asset Group without private capital and the 60/40 portfolios are hypothetical and for illustrative purposes only. Hypothetical results do not represent actual trading. The indices reflect the historical performance of the represented assets and assume the reinvestment of dividends and other distributions. Index returns reflect general market results and do not reflect actual portfolio returns, the experience of any investor, or the impact of any fees, expenses or taxes applicable to an actual investment. Because the HFR indices are calculated based on information that is voluntarily provided their actual returns may be higher or lower than those reported. Unlike most asset class indices, HFR Index returns reflect deduction for fees and expenses.  An index is unmanaged and not available for direct investment. Hypothetical and past performance does not guarantee future results. Please see the end of the report for the risks associated with the representative asset classes and the definitions of the indices.

Don’t let low cash returns interfere with your goals

Holding enough cash in cash alternatives, such as money market funds, to cover living expenses in the event of an emergency is critically important for money management. This practice may allow your longer-term investments to grow over time and reduce the likelihood that you’ll be forced to sell during unfavorable market conditions. However, we suggest holding only 6 to 18 months of living expenses in cash alternatives because of their low returns. Once you have determined the right amount of cash for your circumstances, consider investing any excess. One approach is using dollar cost averaging—investing a set amount over time at a specific interval, such as monthly or quarterly.* We recommend investing the cash in underallocated asset classes first and then spreading it across your full portfolio.

Broaden Your Geographic Scope

Source: Wells Fargo Investment Institute, as of December 29, 2017

*A periodic investment plan such as dollar cost averaging does not assure a profit or protect against a loss in declining markets. Since such a strategy involves continuous investment, the investor should consider their ability to continue purchases through periods of low price levels.

Diversifying can help you avoid the fear of investing at the wrong time

Although we expect 2018 to be another positive year for stocks, no one knows for certain how much further stocks will climb before they experience a significant decline. Holding a variety of assets in an investment portfolio provides the opportunity to participate in market advances while potentially mitigating a market decline’s impact on your portfolio. A diversified portfolio can also be a good place to invest excess cash, knowing that if markets continue to advance, you can reallocate some of your gains to assets that are expected to be less volatile, like high-quality bonds. If markets decline, those less-volatile asset classes should help reduce the potential for portfolio losses.

Diversifying can help you avoid the fear of investing at the wrong time

Source: Wells Fargo Investment Institute, as of December 29, 2017

*Hedge Funds are not suitable for all investors and are available only to persons who are “accredited investors” or “qualified purchasers” within the meaning of U.S. securities laws. Hedge funds trade in diverse complex strategies that are affected in different ways and at different times by changing market conditions. Strategies may, at times, be out of market favor for considerable periods with adverse consequences for the investor.

Whether you have been investing for a long time or are new to managing your investments, we firmly believe that taking steps now to be more nimble can help you recognize potential investment opportunities. We recommend reviewing your portfolio as a regular, routine step, and believe now is a good occasion to contact your investment professional to discuss new opportunities we expect will materialize in the year ahead.