Advice Into Action

Large market moves can significantly alter a portfolio’s risk/reward profile. That’s why we believe now may be a good time for investors to review their portfolios.

August 2017

Paul Christopher, CFA, Head Global Market Strategist
Tracie McMillion, CFA, Head of Global Asset Allocation Strategy

Rebalance to Help Manage Risk

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Buy low and sell high is a strategy many investors hope to follow. But selling high can be challenging in markets like these, when many assets— particularly stocks—have risen considerably in a relatively short period of time. Large market moves can significantly alter a portfolio’s risk/reward profile. That’s why we believe now may be a good time for investors to review their portfolios. Rebalancing—taking profits and reallocating into areas with greater upside potential—may be more important to help you achieve your long-term goals than attempting to generate even greater gains with your current portfolio’s asset allocation targets.1

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

Our Outlook for the Rest of 2017

What We Expect

  • We see continued upside for stock prices through 2018, although rising interest rates could be a near-term headwind for stocks. Modest inflation should gradually lift bond yields.
  • The U.S. is further in its recovery than international markets, which we believe makes global diversification more important.

Actions to Take Now

  • Rebalance your portfolio to your investment plan to keep it aligned with your investment objectives and risk tolerance.
  • Reduce certain riskier asset classes vulnerable to changes that could affect financial markets.
  • Broaden your geographic scope to potentially benefit from improvements in overseas markets.

Rebalance Your Portfolio to Your Investment Plan

Portfolio allocations can drift based on market movements over time. This can cause the risk in your portfolio to misalign with your initial risk target. In the example here, an investment in a simple 60 percent U.S.large-cap stock/40 percent U.S. investment-grade bond portfolio at the start of the latest bull market (since March 2009) would look drastically different today if not periodically rebalanced. The riskier equity allocation might have increased to nearly 82 percent of total assets, and, consequently, the standard deviation (a measure of portfolio volatility) might have increased from 7.57 percent to 13.06 percent.

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

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

Investors Should Consider Rebalancing Now to Help Manage Risk

Investors often construct their portfolios around an investment plan that builds on personal investment goals and risk tolerance. Once an investor has an investment plan, it is important to stick with it. This means periodically reviewing portfolio allocations and rebalancing—or buying and selling assets to get back in alignment with strategic targets. Here are several recommendations that we think will be critical to investor success in the second half of the year.

Reduce Certain Riskier Asset Classes

We see risks among equities and lower-quality bonds as we enter a period of policy transition and heightened geopolitical uncertainty that could affect financial markets. Historically, as the Federal Reserve increases interest rates, equity valuations tend to contract, meaning stocks may trade at lower prices for a period of time. In our view, that means U.S. equity prices are likely to be lower by year-end. We believe domestic small-cap stocks are especially vulnerable to market pullbacks. Relatively tight yield spreads inject risk into lower-credit-quality sectors of the bond markets. We prefer higher-quality bonds at this point in the interest-rate cycle, including U.S. taxable investment-grade bonds—in particular, U.S. intermediate-term taxable bonds.

Reduce Certain Riskier Asset Classes

Broaden Your Geographic Scope

During the past eight years, many investors have added U.S. equity exposure while leaving international allocations below their investment plans’ long-term targets. We believe the U.S. economy is in the final third of its current business expansion, but the expansion in other countries is much younger. In fact, economic fundamentals recently have improved in many overseas markets, particularly in developed markets in the Asia Pacific region and in emerging markets across Asia. We recommend that investors who find themselves overallocated in U.S. positions consider taking profits and diversifying between U.S. and international allocations.

Broaden Your Geographic Scope

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 a good occasion to contact your financial advisor to discuss new opportunities we expect to materialize in the balance of the year.

1 Keep in mind, liquidating holdings could have tax consequences. Wells Fargo Investment Institute and its affiliates are not tax or legal advisors.

Risk Considerations

Asset allocation is an investment method used to help manage risk. It does not ensure a profit or protect against a loss. Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stocks may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks, including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, are subject to greater risks, and are less liquid than large- company stocks. Cash Alternatives typically offer lower rates of return than longer-term equity or fixed-income securities and may not keep pace with inflation over extended periods of time. Bonds are subject to market, interest-rate, price, credit/default, call, liquidity, inflation, and other risks. Prices tend to be inversely affected by changes in interest rates. Municipal bonds offer interest payments exempt from federal taxes, and potentially state and local income taxes. These bonds are subject to interest-rate and credit/ default risk and potentially the Alternative Minimum Tax (AMT). High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value, which may result in greater share-price volatility. Real estate has special risks, including the possible illiquidity of underlying properties, credit risk, interest-rate fluctuations, and the impact of varied economic conditions.

Index Definitions

Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment-grade, U.S.-dollar-denominated, fixed-rate taxable bond market.

Bloomberg Barclays U.S. Corporate High Yield Bond Index covers the universe of fixed-rate, non-investment-grade debt.

Bloomberg Barclays U.S. Municipal Bond Index is composed of long-term tax-exempt bonds with a minimum credit rating of Baa.

Bloomberg Barclays U.S. Treasury Bills (1–3 Month) Index is representative of money markets.

Bloomberg Commodity Index is calculated on an excess return basis and reflects commodity futures price movements.

FTSE EPRA/NAREIT Developed Index is designed to track the performance of listed real-estate companies and REITS in developed countries worldwide.

Ibbotson Associates SBBI U.S. Large Cap Stock Index tracks the performance of the S&P 500 Index stocks.

Ibbotson U.S. Intermediate-Term Government Bond Index is an unweighted index that measures the performance of five-year maturity U.S. Treasury bonds.

MSCI EAFE Developed Market (DM) and Emerging Markets (EM) Indices are equity indices that capture large- and mid-cap representation across 21 DM countries and 23 EM countries around the world.

Russell 2000® Index is composed of the 2,000 smallest companies within the Russell 3000® Index.

Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000® Index.

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.

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 registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions, or communications made with Wells Fargo Advisors.

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 nonbank affiliates of Wells Fargo & Company.

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