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The end of the year is a time to enjoy holiday parties, make New Year’s resolutions, and ensure your portfolio is ready for 2024 and beyond.
First, you should take care of basic housekeeping: fund your IRA, pay off any high-interest debt, and look into tax-loss harvesting within your taxable accounts. Also consider increasing your 401(k) contributions. The Internal Revenue Service raised the limit for 401(k) and other retirement plans to $23,000 for 2024, up from $22,500 for 2023.
A pro move: Consider converting a traditional IRA to a Roth IRA, which means paying taxes today, but your investments will grow tax-free in the Roth account. A Roth conversion makes sense for investors who anticipate being in a higher tax bracket in the future, or who intend to leave a Roth IRA as an inheritance to their children who will be in a higher tax bracket.
Potential tax changes are on the horizon and that may make this an ideal time to do a Roth conversion, says Jonathan Shenkman, president and chief investment officer of ParkBridge Wealth Management. The Trump-era tax cuts, for example, are due to expire in 2025. And Congress will probably have to tackle the ballooning federal budget deficits with tax increases, spending cuts, or a mixture of the two. “If you’re the kind of person who likes to plan ahead, then this is a good opportunity,” says Shenkman.
After that, investors should dig into their portfolios with an eye on the long term so that they are poised to take advantage of the return of more conventional market dynamics. The Federal Reserve is just about finished raising interest rates, the economy is projected to grow moderately, bonds are offering income, and stocks are rising and falling based on profits. “We’re back to normal,” says Lisa Shalett, chief investment officer for
Morgan Stanley Wealth Management
.
Investors need to “wrap their brain around this idea.”
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The recent market dynamics mark a significant shift from the period from the 2008-09 financial crisis through 2021, which was characterized by rock-bottom interest rates and paltry yields on bonds. Investors did well with the FAANG stocks (
Facebook
,
now
[ticker: META];
[AAPL];
[AMZN];
[NFLX]; and
Alphabet
,
formerly Google [GOOGL]), as did those who favored U.S. equities over international stocks. But yesterday’s playbook may not work as well going forward.
In some ways, we’ve reverted to historical form. Mortgage rates, for instance, are near 8%. That may sound crazy high to millennial home buyers, but it isn’t unheard of for baby boomers and Gen Xers. Higher interest rates also mean investors can actually get a respectable yield on the cash portion of their portfolios. “You can earn about 5% in a money-market fund,” says Kara Murphy, chief investment officer of Kestra Investment Management. “We haven’t seen that since 2007.”
For investors, year end is an opportune moment to take a close look at their portfolio and financial goals. That means making sure you have the right asset allocation for your goals. Even if you do, you probably still need to rebalance to make sure you aren’t overweight cash, light on bonds, and heavy on stocks (a lot of people are). A 60/40 stock/bond mix makes sense, but investors should also consider how they deploy cash now—to make sure it is generating some yield—and maybe consider adding alternative investments, like venture capital or private credit. And keep a cautious eye on the pricey Magnificent Seven tech stocks: Alphabet, Amazon, Apple, Meta,
(MSFT),
(NVDA), and
(TSLA). They are so 2023.
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Here’s wisdom from the pros on setting up each part of your portfolio for the new year.
Stocks
While rebalancing usually means adjusting your allocations of stocks, bonds, and cash, this year you also may need to rebalance within your stock portfolio. Given that just a handful of stocks have provided much of the market’s overall returns this year, you may be way overweight the Magnificent Seven: Those stocks have outperformed the rest of the S&P 500 significantly. Their return from Jan. 1 to Oct. 31 was 53.2%, compared with 1.2% for the other 493 stocks in the bellwether index, according to asset manager
Tim Murray, capital markets strategist in T. Rowe’s multi-asset division, said the Magnificent Seven have almost become their own asset class. “It’s been such a top-heavy market,” Murray said at a Nov. 14 presentation. “That is distorting valuation and allocation.”
Top-heavy markets have occurred before, and the stock performance of the Magnificent Seven may be justified. But investors should check across their holdings to see how much exposure they have to these seven stocks in particular, and to growth and tech stocks more broadly. “Revisiting concentrated positions is really valuable right now,” says Evan Bloomberg, a private wealth advisor at
UBS
.
“If a client has more than 10% of their net worth in any asset, we want to check that against their plan and make sure they are protected.”
Morgan Stanley’s Shalett recommends positioning portfolios to be slightly underweight equities. “We are not excited about owning the S&P 500 at a market weight,” says Shalett. “It is dominated today by seven stocks that are correlated with each other, and they are all superexpensive as a starting point.”
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Instead, she sees opportunity in areas that are more interest-rate sensitive and could therefore benefit if rates stabilize or fall. She finds potential value in healthcare, energy, industrials, and small-caps—sectors that have underperformed the broader market and may be poised to catch up in 2024 if the economy continues to run not too hot and not too cold.
“As value investors, we’re betting on mean reversion,” Shalett says. “If this Goldilocks story is real, then you’re going to have a catch-up trade. You’re going to see the things that have underperformed, and that are most sensitive to interest rates, come back.”
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Investors should also review their allocation to international stocks, which have lagged behind U.S. stocks in recent years. That could change. Asset manager Vanguard estimates that 10-year annualized nominal returns will be lower for U.S. stocks than for non-U.S. developed markets equities; Vanguard projects 4.2% to 6.2% for U.S. stocks compared with 7% to 9% for non-U.S. developed markets equities.
Other wealth managers are slightly underweight international stocks, citing, for example, weaknesses or risks in Europe. But they aren’t forgoing international equities. Sequoia Sentinel Family Office, a unit of Sequoia Financial Group, currently recommends international equities for 30% of equity exposure. That’s less than the firm’s 35% long-term strategic target but it’s still a healthy allocation, says Michael Orfe, advisor group lead at Sequoia Sentinel Family Office. “There are periods of time when international can outperform U.S.,” Orfe says.
Cash
Investors have increased their cash holdings over the past year—and with good reason. Interest rates are higher than they’ve been in decades, and money-market funds are currently yielding around 5%. Investors would be wise to make sure that the cash part of their portfolio is generating some income in this environment. “If you’re not being proactive on this, then you’re leaving money on the table,” says ParkBridge’s Shenkman.
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Some investors may also be overweight cash and should move back into longer-term bonds. If longer-term interest rates continue to fall, there are gains to be made. And yields on cash could fall if the Federal Reserve cuts rates.
Bonds
For these reasons and more, investors should re-evaluate the fixed-income portion of their portfolios.
Some financial advisors have been recommending clients buy longer-dated Treasuries now to lock in today’s higher yields.
“The clock is ticking between here and a Fed pause,” says Bloomberg, the UBS advisor. Yields, which dropped in the past month, will continue to fall if the Fed gets more dovish. “That means there is reinvestment risk. By the time the Fed does pause, there is a risk for it being too late to transition from cash to bonds.”
Fixed income has taken a beating since the Fed started hiking rates. Kestra’s Murphy says the Federal Reserve’s rapid rate increases meant the “bond market had to take these hits in a very concentrated way.” But yields on bonds are now attractive in a way they haven’t been in years.
Owners of long-term bonds may also benefit should rates continue to fall (as they have this month) and the economy slow down; in that scenario, their bonds could appreciate in value, and investors could then sell them at a profit. Consider this: The $49.2 billion
iShares 20+ Year Treasury Bond
ETF (ticker: TLT) is up about 9% since mid-October.
Some investors may choose to buy longer-dated bonds and simply hold them to maturity, collecting the coupon without having to worry about fluctuations in the underlying price of the bond.
Morgan Stanley’s Shalett notes how fixed income compares favorably with stocks, particularly given valuations. “I’d just as soon take 5.5% in investment-grade paper as buy a company stock at these levels,” she says.
Retirees or investors nearing retirement in particular may benefit from the higher yield environment because they can generate attractive income from safe investments. That wasn’t possible before the Fed started hiking rates in 2022. And in the previous decade, some investors seeking higher yields might have bought riskier investments such as junk bonds or leveraged loans. As part of rebalancing within the bond portion of their portfolios, investors should make sure they aren’t overallocated to riskier fixed-income investments.
“With rates going up, a lot of these weaker companies that took on more risk over the past 10 to 15 years, they could default,” says Shenkman. “That’s another reason to move up in credit quality; you want to limit your exposure to these riskier assets.”
Shenkman says retirees shouldn’t forsake stocks for fixed income. That’s because they face longevity risk, or the risk that they will live a very long time and inflation will erode their buying power. “If you want to outpace inflation, you need a meaningful amount of equity exposure,” he says.
Alts
For high-net-worth and ultrahigh-net-worth investors, it’s also important to consider an allocation to alternative investments—but it isn’t a must-have. More investors have bought into alts, particularly high-yielding funds that invest in private credit and real estate. Alternative-asset manager
said in a recent paper that incorporating private credit, private infrastructure, and private real estate can increase the income potential of a portfolio. The firm’s hypothetical portfolio consisted of 40% bonds, 30% stocks, and 30% alts (which consisted of 15% of private credit and 7.5% each of private real estate and private infrastructure).
Sequoia Financial’s Orfe says they’ve been suggesting that clients invest in private credit, or portfolios of direct loans to midsize companies. Private credit is growing as an asset class because some banks have scaled back lending and others are focusing more on larger borrowers.
Of course, alts aren’t for everyone. For starters, some alternative funds lock up your money for extended periods of time or have limits on how fast you can exit. Fees and investment minimums can be high. So, alts are worth a look, but many investors may do just as well with a traditional mix of stocks and bonds.
Whatever your long-term goals, the key is to make sure you have asset-allocation targets to help you meet them and then make sure each quarter that your actual investments align with those targets. It can be easier said than done. This year in particular, investors should avoid making outsize bets based on past market conditions. Instead, align your investments for the more normal market environment that lies ahead.
No allocation can be the right one if it doesn’t help you achieve your financial dreams. “A portfolio is much more powerful when it is tied to a financial plan,” says Kestra’s Murphy.
Write to Andrew Welsch at andrew.welsch@barrons.com
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