Changing that half-empty glass to half full

Tracie McMillion
Head of Global Asset Allocation Strategy
Wells Fargo Investment Institute

Will the Federal Reserve (Fed) hike interest rates further? Is the economy heading into a recession?

These are big questions investors face as 2023 progresses. Of course, as with anything involving the future, no one knows the answers for sure. But if the Fed’s interest-rate increases do trigger a recession, it could have a negative impact on the markets.

So what should investors be doing now in the face of potentially rough waters ahead? Rather than worrying excessively, I suggest taking what could be a negative and trying to turn it into a positive. Investors can use this moment as an opportunity to take a good, hard look at how they’re invested and make moves that could help them weather a market downturn and be better prepared for the long term.

Obviously, what any investor should be thinking about depends on their situation. In fact, many may not need to change a thing. With that in mind, here are just a few questions to consider.

Does the investor have a plan?

Whenever there’s a market downturn, it seems to me that it’s the investors without a plan who are unsure about what to do next. Those who have a plan, on the other hand, should be better prepared because, during the process of building their plan, they’ve likely given some thought to the potential for volatility and how well they can stomach it.

For investors who don’t have a plan, I strongly encourage working on it now. When developing a plan, start with investment goals in mind and match different types of investments, such as stocks, bonds, and cash, to an investment objective. Of course, an investor’s allocation could be much more complex based on their situation.

An allocation also needs to be based on the investor’s time horizon and risk tolerance. It’s the latter that’s most important when it comes to the possibility of a recession. If an investor has appropriately aligned ahead of time, they should be better positioned to withstand further market declines.

Is rebalancing needed?

Creating a plan is like planting a garden; it’s a great start, but it needs to be tended to over time.

That means an investor needs to help ensure their plan stays up to date when there are life changes, such as a marriage, divorce, birth of a child or grandchild, or death. Whenever a significant event occurs, it’s time to revisit their plan and, if necessary, make adjustments.

Market activity’s impact is another major concern. If an intended asset allocation is, hypothetically, 60% stocks/35% bonds/5% cash and stocks have a very good year and bonds have a bad one, that allocation could drift to, for example, 65% stocks/30% bonds/5% cash without the investor being aware of it. That could result in greater risk if there’s market volatility.

Rebalancing a portfolio by revisiting it periodically and determining whether there’s a need to sell some investments and purchase others can be almost as important as having a plan in the first place. Last year was rough on both stocks and bonds, which means rebalancing may be more necessary now than it typically is.

How are stocks allocated across sectors?

With a recession potentially in the offing, we currently recommend positioning stock portfolios more defensively. That is, we think investors should be more heavily invested in sectors that tend to hold up better when there’s a market downturn because they provide products and services consumers need regardless of what’s going on in the economy. (Cyclical companies, on the other hand, historically have tended to perform better when the economy is doing well and worse when there’s a slowdown.)

Consult your advisor

As I said, no one knows for certain whether there will be a recession or, if there is one, how deep and long it will be. But in light of the possibility of one, consult your financial advisor to address these or any other questions you may have about your investments.