If you think that stocks and bonds generally move independently, you are not wrong. This is one reason they complement each other in a financial portfolio – bonds can provide stability and balance volatility in stocks.
However, that hasn’t happened yet. Year-to-date, the S&P 500 is down more than 20%, while the bond market is also down about 15% as of October 24, 2022.
Here’s why experts think this is happening and what consumers should do to weather this storm.
Inflation and rising interest rates affect stocks and bonds
Many factors affect the stock and bond markets. Anessa Custovic, chief investment officer at Cardinal Retirement Planning and economist, said that when we see correlations between assets — that is, when stocks, bonds, gold, real estate or other investments move in the same direction — it’s due to correlation due to economic trends.
In this context, Chapel Hill, N.C.-based Custovic said consumers are feeling the pain of top-down macroeconomic forces such as lingering pandemics, supply chain issues and geopolitical crises.Not to mention, America is going through high inflation 40 years no see.
The U.S. central bank, known as the Fed, wants to control inflation, and one of the tools they have to do so is interest rates. By raising interest rates, the Fed is raising borrowing costs, which could slow economic growth and keep inflation in check.
This can feel different and uncomfortable because it is.
“Typically, we don’t raise rates when financial conditions have tightened and uncertainty is happening,” Custovic said.
How interest rate hikes affect stock prices
The immediate side effect of higher interest rates is a drop in stock and bond prices.
For stocks, interest rates can affect a company’s capital and earnings in a number of ways, said Damian Pardo, a certified financial planner and regional director of wealth management at First Horizon Advisors in Coral Gables, Fla.
First, the company earns less. In an environment of rising interest rates, the cost of debt for companies could become more expensive, eroding earnings. As earnings fall, their stock prices are likely to fall.
Second, there are few people. If consumers have less money available because of inflation, “income could take a hit, because [consumers] May not buy your product like you did the year before. “It may look like consumers are putting off buying their next tire, cell phone, refrigerator or vacation because each paycheck is buying less than before.
Third, bad news can take its course. Some rushed to sell as financial analysts reported lower consumer spending and higher capital costs, word gaps, stock expectations changed.
“All of this is putting pressure on stock prices,” Pardo said.
Why rising interest rates also push bond prices down
Rising interest rates also affect bond prices. Bond interest rates are usually set when the bond is purchased. When interest rates rise, new bonds are issued at higher rates and become more popular than bonds with lower rates. As a result, the value of bonds that people already hold at lower interest rates will fall. This is the most immediate concern for bondholders looking to sell in the short term.
However, Pardo stressed that it was important not to panic. If you hold high-quality bonds and hold them to maturity, you may still receive the principal and yield, he said.
However, if you must sell early, keep the following strategies in mind.
How to Manage Your Portfolio During a Downturn
Bear markets and falling prices don’t last forever. Everything is different, and one thing remains true: selling when the market is down means locking in your losses, so it’s best to avoid it if you can.
In the meantime, consider these four strategies to adjust your financial plan and mindset in tough times.
1. Reflect on whether your financial goals are flexible.
Do you need to use this money? If you don’t need the money right now, sit tight.
If you plan to retire soon, you could be in a recession, “which can be one of the worst-case scenarios for keeping your money going into retirement,” Kustovic said.
While for some retiring people, working another year to ride out the downturn is an option, for many others, it’s understandable. So it’s normal and valid if you can’t get an income because you’re relying on your investments, have a disability, or have no choice.
2. If you have excess cash reserves, rely on them first.
A cash reserve is an important part of any financial portfolio; it’s a way to keep resources in an easily accessible location in an emergency.
If you have it, you can choose to use it, Pardo said.For example, if your emergency fund Include more than six months of living expenses, maybe you can use your emergency fund for three months while keeping the rest.
It can make strategic sense to spend your limited cash in a way that still retains your emergency fund. Using cash first, rather than selling other assets, will keep you invested, ideally long enough to benefit from an eventual recovery.
3. As a last resort, strategically consider which assets to cash out first.
“How, and when, money is taken out of a portfolio has a big impact on how long that money lasts,” Custovic said. “If you need to withdraw funds, start with the assets with positive returns or the least losses.”
4. Get help. If this feels complicated, it’s because it is.