Photo: Flickr / Ravages
Are you ready to make some tough election-year decisions about your portfolio?Many investors have seen their nest eggs recover from the debacle that hit in 2008 and want to preserve and protect.
The Romney vs. Obama election promises to be more of a game-changer than past elections. The urge for many will be to get more conservative with investments until the battle is over in November.
“There is a need to be more defensive because there is always some uncertainty ahead of election period. It is compounded this time,” says Russ Koesterich, global investment strategist for BlackRock’s iShares ETF unit.
Not only are there sharp policy differences between the candidates, he says, but also whoever wins will start his term facing fallout from the “fiscal cliff,” as a raft of still-undetermined programs aimed at stimulating the economy end January 1.
But how do you go “safe” when so many investing rules have changed? Most people have been cautious in recent years, so a few small adjustments might do. But with interest rates at historic lows, the old ways of “locking down” a portfolio might add, not remove, risk.
Here are four steps to secure your portfolio for the November 6 voting day and beyond, regardless of who wins:
Shift equity mix to big stocks. The danger with smaller growth stocks is that they are more susceptible to any downturn if Washington hits a post-election stalemate. That fiscal cliff is less of a threat to the largest U.S. companies because they derive more of their earnings abroad.
“We are not recommending a big shift out of equities into fixed income,” says Koesterich. He recommends putting equities in large-capitalisation U.S. stocks, which are “relatively undervalued” compared to other alternatives, and can also offer dividend yields that are close to those of government bonds.
“We would not be buying government bonds,” says Mark Germain, chief executive officer of Beacon Wealth Management. “Yields have hit bottom and interest rates will be going up, if anything.”
Become more global. The U.S. economy has been steady compared to those of Europe and Asia this year. That could change in the post-election period. The November-to-January period is always a time of intense political manoeuvring in Washington, and there is usually little concrete action. In the balance is $600 billion in tax increases and spending cuts in the new year, Koesterich says, which could create “an immediate 4 per cent drag on GDP.”
In the fight over how to get off the cliff, it’s possible that there could be another Washington showdown like the budget ceiling stalemate that slammed markets last year, he says.
He suggests selectively adding some international equities and fixed income, partly because U.S. treasuries will not be the safe haven they were in the past. Other countries have their own fiscal cliffs ahead of them, but those dangers are understood, while the U.S. precipice is not fully anticipated by the U.S. markets. “It’s not a bad idea to add some international fixed income, even a little bit in emerging markets,” he says. They offer higher yields and the potential for still more gains if the dollar weakens.
Limit risk in fixed income. It could be time to take a close look at your fixed-income holdings. In the past, becoming “more defensive” with your portfolio traditionally meant loading up on treasuries. That could add to risk if bonds fall, which would happen if rates returned to normal levels of 4 per cent to 5 per cent. Koesterich says a better choice for yield-hungry investors right now might be higher-yielding but still investment-grade corporate debt or municipals.
On the other hand, it could be a good time to cash in any high-yield bonds and floating-rate high-yield funds. After a stellar year, they could be hit hard in a fiscal crisis, political stalemate, or economic slowdown. Investors often put their money in short-duration bonds and funds when they sense volatility coming. “People have to remember that those are not money market funds, and their value can rise and fall,” says Koesterich.
Find income without bonds. Preferred stocks and selected real estate investment trusts (REITs) can be a relatively safe way to get income that is not too dependent on the election. Germain likes REITs that are made up of government-backed mortgages. The Fed is buying up mortgage securities at a rate of $40 billion a month, lending support to that sector. Germain’s favourites are iShares Mortgage Plus Capped Index Fund (symbol: REM) and Market Vectors REIT Mortgage Income ETF (MORT), as well as PIMCO Real Estate Real Return Fund (PETAX). But be careful with other REITs that derive income from rental properties. Their yields could be less attractive as home buying improves.
In the “other income” category, Koesterich favours preferred stocks. Some ETFs made up of preferred stocks yield as much 6 per cent. Large-cap companies’ dividends are another income source, and unlike standard government bonds, the payout can rise in a stronger economy with more inflation.
The bottom line on portfolio allocation. There is no one solution when it comes to allocation. It depends on your goals for retirement, your age, and other factors. “It really depends how aggressive you want to be with your investments,” says Koesterich.
Still, the U.S. presidential election is a good time to check your allocations because it tends to mark the start of a new investing cycle. The pattern has been for markets to perform better in the second half of four-year terms. For some undecided investors, locking things down now will give them time to consider the long term and eventually put more money to work.
“It’s reasonable to want to raise some cash with all of the uncertainty. But people now already have a lot more cash sitting in accounts than they should,” says Koesterich. “When I talk to our advisers, they say most people have huge cash piles.”
NOW READ: 20 Products With Astronomical Markups >