Investing for retirement, or any other objective, always carries a degree of risk. There are potential risks specific to 2016 that retirement investors should be aware of as this year comes to an end. There are also potential risks in any year that you should watch out for, according to Mike Piper, personal finance author and founder of the Oblivious Investor blog.
Having a significant amount of your portfolio invested your employer’s stock can be a big risk. “While familiarity with the company may make it feel safe, it’s anything but,” said Piper. “Having both your job and your portfolio exposed to the same set of risks creates a very dangerous situation.”
Also, if your portfolio contains actively managed mutual funds (i.e., non-index funds), make sure you have a solid understanding of how the fund managers are investing. “During every market downturn, there are a handful of actively managed funds that ‘blow up’ in a spectacular manner — declining much more than investors anticipated, because the investors didn’t have a good understanding of the degree and types of risks the fund managers were taking,” Piper added.
Adjusting your long-term asset allocation based upon potential market risks in 2016, or any other year, is generally a poor idea, Piper added. However, it’s also a good idea to be aware of trends and what they can mean for your money. Here are five reasons why your nest egg could be at risk in 2016.
1. The Bull Market Might End
The current bull market began on March 9, 2009, according to the S&P 500 Index. Although there have been a few hiccups in 2015, and at a few other points during this run, this market is currently six years in. It’s the third-longest bull market in U.S. history, according to a report by Bespoke Investment Management.
The S&P 500 Index has gained 1,329 points through the last week of November, since the lows of March 2009 — a bit over three times the average gain during a bull market. There’s no rule that a bull market must end at a particular point, but they don’t go on forever. Furthermore, stock market risk is always heightened as a bull market progresses.
2. China’s Economy Affects Ours
This last summer, the stock market experienced steep losses and a high degree of volatility. A good deal of this was due to China’s economic troubles. In this interconnected world, what happens in the world’s second-biggest economy has an impact on the U.S. economy and financial markets.
A slowdown in China’s consumer economy, and a devaluation in its currency, hit a number of large U.S. companies that are doing business in China. Among the major companies that felt the impact were Apple, Yum Brands, Caterpillar, Boeing and General Motors.
Here’s one example of the impact China can have on our markets in a day: When China decided to devalue its currency, Apple and Yum Brands shares each dropped about 5 percent in a single day. Note that Apple makes up about 3.57 percent of the S&P 500 index and is a major market benchmark.
3. International Markets Are Uncertain
Beyond China, other international markets also have an impact on the U.S. Because a well-diversified portfolio includes international exposure, both in developed and emerging markets, changes in those markets would be reflected in those portfolios.
“The outlook for international markets — Europe, Asia, Latin America and emerging markets — continues to be unclear,” said financial advisor Cathy Curtis. “As most diversified portfolios have a percentage allocated to stocks in these regions, they could continue to be a drag on portfolios. However, to not hold an allocation to international and emerging stocks could hurt a portfolio when these economies do improve.”
It’s this uncertainty that is a big risk to U.S. stocks in the coming year, according to Russ Koesterich, global investment strategist for money manager BlackRock. “Emerging markets account for a growing percentage of global growth, and the recent slowdown in the emerging world isn’t limited to China, as data from Bloomberg demonstrate,” he wrote in a recent economic outlook. “Economies in Brazil and Russia are contracting, and most large emerging markets, with the possible exception of India, are slowing, according to the data.”
4. Tragic Events Have an Impact
When it comes to terrorist acts, the impact on our portfolios is secondary to the human toll. However, some sort of major terrorist attack would certainly affect our financial markets and your retirement nest egg, at least in the short-term.
“The Paris attacks emphasize how vulnerable the world is to terror,” said Curtis. “Markets don’t like uncertainty, and investors could decide to put their money in safer havens — cash or short-term bonds, gold. Diversified portfolios would be vulnerable to this shift.”
5. Interest Rates Might Increase
When the Federal Reserve didn’t raise interest rates at its last meeting, experts began speculating in earnest as to whether it would do so by the end of the year. An interest-rate increase will impact holders of fixed-income mutual funds, exchange-traded funds and individual bonds. The price of a bond moves inversely with interest rates.
A statistic called duration, which Morningstar and other sources provide for fixed-income mutual funds, can illustrate this. The largest bond mutual fund with Vanguard Total Bond Market Index Investor Shares currently has a duration of 5.72 years, according to Morningstar. What this means is that a 1 percent increase in interest rates would result in a 5.72 percent decrease in the value of the underlying bonds held by the fund. If you hold a longer-duration bond fund, the impact will be greater.
Bond duration is an imperfect indicator, but it can give investors a good idea of the impact on the value of their bond fund if interest rates rise. The interest rate earned from the bonds in the fund will partially offset the impact of rising rates. Investors should keep the impact of their fund’s duration in mind and might consider shortening up on the length of their bond holdings.
Certainly, there are risks to your retirement nest egg in 2016. However, one of the biggest risks is overthinking what can go wrong. That doesn’t mean you should ignore what’s going on in the financial markets and the economy, but trying to time the markets based upon these or any other risk factors is not the best strategy. Retirement investors should consider investing with an asset allocation that is based on their time horizon for needing the funds, their risk tolerance and their goals.