Don't let the bear catch you unaware. Image: Wikimedia Commons.
The health of the U.S. economy has helped lift stocks higher over the past several years, and the Dow Jones Industrials (^DJI 0.06%) remain within just a few hundred points of the average's all-time high-water mark. Yet recently, we've seen increasing turbulence in financial markets, as various pressures both domestically and internationally have asset prices moving in more volatile fashion. With both stock and bond prices still near historical highs, now is a great time to do three things to ensure your portfolio will behave the way you want no matter which direction the markets move in the near future.
1. Know your bond risk.
Over just the past few weeks, the bond market has been roiled by extremely large movements in European sovereign debt. In Germany, for instance, rates on the 10-year bond have gone from below 0.1% to about 0.7% since mid-April. As small a difference as that might seem, the move translates into huge capital losses for investors who invested in German bonds -- and with such low interest rates, the bonds didn't produce any appreciable income to compensate investors for the risk.
With 10-year Treasuries yielding roughly 2.25%, U.S. investors might think they're immune to the trend, But those rates are up more than half a percentage point since early February, and further rises are likely as the Federal Reserve considers future action.
If you own bonds -- especially in bond funds -- rising rates will reduce prices, and the longer the duration of your bonds, the greater the losses you'll suffer. Now is the time to assess how much bond risk you have and to adjust accordingly to fit your income needs and risk tolerance.
2. Know your stock risk.
Stocks have soared over the years, in part because of substantial earnings growth and in part as market-multiple valuation levels have risen. What's surprising, though, is where the highest-valued pockets of the stock market are found.
Throughout the rise, many investors have been skeptical about stocks and have gravitated toward defensive issues in industries such as consumer staples. Blue-chip stocks in those arenas don't always have huge growth rates, but they have nevertheless acquired healthy earnings multiples that some argue aren't sustainable.
In particular, if you own a large number of blue-chip dividend-paying stocks, look at their valuations to see if they might have overextended themselves. Sometimes, you'll find risk in unsuspected areas, and taking action now while those valuations are still high can prevent pain later.
3. Balance your portfolio.
Finally, even though both stocks and bonds have risen in recent years, stocks have made greater overall gains. If you haven't rebalanced your portfolio, then your allocation to stocks could be much higher in percentage terms than it was the last time you reset your portfolio to your targeted percentages. Rebalancing now can help you reduce positions, locking in profits and limiting exposure to the next downturn.
Market volatility is a fact of life, and investors must grow accustom to both ups and downs in markets. In the long run, though, the steady rise in stocks produces the returns that investors need to succeed. That said, minor moves to control risk like the ones listed above are essential to make the most of your portfolio opportunities.
