How to invest when stocks and bonds are both crashing, according to experts

It used to be that, when stocks went down, bonds offset that loss by going up. That’s why the classic advice is to have a 60-40 investment portfolio, with 60% stocks and 40% bonds. Stocks historically have been the chief engine of wealth creation, as they increase more over time than any other asset class; bonds provide ballast to more volatile equities. But thanks to the 2022’s unholy trinity of interest rate hikes, inflation and war, both asset classes now are in the red, which trashes the old 60-40 guideline.

The main stock index, the S&P 500, has lost 15.9% for the year, and its counterpart, the Bloomberg U.S. Aggregate bond index (known as the Agg), is off 10.5%. Such a double-whammy is rare: The last time they both were negative was in 1994. Even in the 2008-09 financial crisis, bonds gained when stocks lost.

How can you weather the current unpleasantness? Here are five precepts to follow in navigating the dangerous shoals of investing in a downdraft. Or any time, for that matter, because you never can be sure when a market landslide will materialize and knock you off your feet. Your focus should be on how to position your finances for the long run.

Don’t get spooked

When your stocks plummet, it’s human nature to want to cash out—to unload the whole batch of them before equities go to zero. If you do, though, you’ll only harm yourself, because they will come back. That’s why the venerated investing sage Warren Buffett once said his holding period for his securities was “forever.” To Dave Gilreath, chief investment officer of financial firm Innovative Portfolios in Indianapolis, “You just can’t let yourself get spooked and sell.”

During the 2008-09 horror show, the S&P 500 lost around half its value. It took a little over two years to recover. But the point is that it did recover. And stocks never were in danger of going to zero. A fall to zero didn’t even happen during the Great Depression.

Plus, if you cash out, getting back into stocks can be expensive. You’ll likely pay more to rejoin a rising market than the cash you pocketed when you bailed. Even the wisest financial pros are lousy at timing the market. Timing means knowing exactly when the market will take off and how long a rally will last. From the market’s March 2009 bottom to its recent peak, the S&P 500 expanded five-fold, a trajectory that wasn’t foreseeable in early 2009.

Right now, equities are in a correction, defined as dropping 10% to 20% from the market peak. Since World War II, there have been 27 of them, with an average slide of 13.7%. We’re close to a bear market, defined as down more than 20%; since 1945, there have been 14 of those.

What’s the deal with bonds lately? The Agg has posted just four losing years since 1980, while the S&P 500 has clocked seven, and the stock falls were much deeper than the bond dips. The Federal Reserve’s newly launched campaign to boost interest rates has hurt the Agg, as bond prices move in the opposite direction from rates.

A plausible case exists, however, that inflation won’t stay as high a now (8.5% annually in March), and thus the Fed won’t push interest rates to a crushing level. The so-called breakeven rate, which measures what investors project future inflation to average over the next five years, is 3.2%. While that’s higher than the sub-2% level that the U.S. enjoyed for a long time, it’s a helluva lot less than the current Consumer Price Index (CPI).

If that benign inflation forecasts holds, then interest rates probably would climb higher than the CPI, which isn’t the case now. That would be a boon to investors, whose current bond returns are getting whittled away by inflation. Futures contracts expect the federal funds target rate (the Fed’s benchmark) to be as high as 3.5% in mid-2023, up from 0.75% to 1.0% now.

Rebalance

The advice to stay put when the market slips assumes that you have a solid investment plan. Investments should be constructed with care. While the traditional 60-40 stock-bond mix is a good starting point, your portfolio should be crafted to reflect your age, risk tolerance, other expected income (a pension, an annuity, etc.) and needs.

Do you need your investments to fund a home purchase, kids’ college tuitions, your retirement, etc.? “The specific asset allocation is very personal,” says Daniel Crimmins, a financial advisor who with his wife Maureen runs Crimmins Wealth Management in Ramsey, N.J.

Hiring a planner, like the Crimmins firm, gives you a professional asset allocation designed to make your money last through your life. For instance, many planners use a computer-guided procedure called a Monte Carlo simulation that factors in your needs and financial situation, calculates the odds of your wealth persisting through your lifespan, then helps form a personalized asset allocation. Some more self-directed folks use robo-advisors, online programs that give them templates tailored to their requirements. Other investors study up and do the task themselves. The main thing is that they have a rational plan.

Of course, every allocation should be rebalanced, usually yearly, as some asset types grow faster than others, messing up the preferred mix. The run-up for stocks through last year tended to skew portfolios away from the 60-40 paradigm. Even Buffett, despite his forever mantra, rebalances his holdings. Many 401(k)s offer target-date funds, which as you age automatically grow more conservative, with the bond portion expanding and the stock segment shrinking.

Stay focused on the long run

In his masterpiece investing study, “Stocks for the Long Run,” Jeremy Siegel, a professor at the University of Pennsylvania’s Wharton School, calculates that stocks have outpaced other asset classes for two centuries, returning 7% annually after inflation. “Even such calamitous events as the Great 1929 Stock Crash did not negate the superiority of stocks,” he writes in the book.

Other studies have backed up Siegel’s finding. Stocks lose an average 36% in a bear market, by the reckoning of Ned Davis Research. The good news is that they gain an average 114% in a bull market.

The question then becomes: which stocks to own and how?

The U.S. has more than 4,000 listed equity issues, and many more are available overseas. Mutual funds and exchange-traded funds (ETFs) are a good way to invest in stocks, as a pro is managing your money. A lot of financial advisors suggest using index funds, which track broad swathes of the market, such as the S&P 500. Research shows that they do better than actively managed funds. More adventuresome souls may want to do their own stock picking.

The trick with individual stocks is to do proper due diligence. Make sure a company has a strong market presence and a promising future, with not too much debt and ample revenue and cash flow, plus solid management.

A bonus for investors is that stocks today are on sale. The S&P 500’s price/earnings ratio, the gauge of how costly shares are, has descended to 20 from 29 last year, Yardeni Research stats show. Overall, U.S. equities are undervalued by 12% of their true worth, says Dave Sekera, chief market strategist at research house Morningstar. What’s more, growth stocks—that is, largely the tech names that last year were hot—are 17% undervalued, he estimates. Example: Microsoft, which has lost 27% this year, and doesn’t deserve to be where it is, Sekera writes.

As stocks are the most closely linked to the U.S. economy, faith in the latter should breed faith in the former. The same could be said of foreign stocks that also have been slammed. Such is the take of Lewis J. Walker, a financial planner with Capital Insight Group in Peachtree Corners, Ga. “For the long run,” he says, “a portfolio of well-selected and diversified stocks is a good bet to grow along with America, and bursts of technological innovation around the globe that have been going on since the Industrial Revolution.”

Diversify with care

The bedrock of any portfolio is diversification, and with a 60-40 allocation, your bonds should in theory counter-balance your stocks. Although this goal sounds laughable at the moment, bonds are important and should regain their previous function once inflation and other maladies settle down.  

But there are bonds and there are bonds. Standard fixed-income advice for when rates are rising is to concentrate on short-term bonds, as they give better flexibility. You aren’t locked in for long periods and short-term bonds’ prices are less sensitive to higher rates. You can access them by purchasing individual securities or via mutual funds and ETFs.

Short Treasury yields are rising faster than those for long-dated government bonds, so you can get not-bad income with less price risk on the short end. The two-year Treasury yields 2.61%, not that far below the 10-year, at 3.05%, just a 0.44 percentage point difference. Go back 12 months, and the gap was almost triple that, 1.18 points.

As you don’t look for big price appreciation in bonds, income becomes important, and here the escalating rate regime is your friend. I-bonds, an inflation-protected Treasury security, which is virtually risk-free because it’s government issued, pays a 9.62% rate through October 2022. The downside is you can’t cash it in for a year, and must pay a penalty if you exit within five years. Plus, you can’t buy more than $10,000 worth per year.

Corporate bonds pay higher yields, and for a reason. They are riskier. Uncle Sam is highly unlikely to default, and XYZ Corp. may give you a nasty surprise.  Investment-grade corporate bonds—that is, not junk-rated—offer decent safety. Over the past four decades, they averaged around a 2% default rate, compared with three times that for junk, according to S&P Global Ratings. And investment grades also sport yields averaging 4.46% yearly.

A cautionary note: Some assets are not well-suited for the long term, even though they are on fire now. Commodities, which for the most part are flying high these days amid shortages, can be problematical, as their prices are very volatile. Liz Ann Sonders, chief investment strategist for the Charles Schwab brokerage firm, warns in a commentary that commodities can be “treacherous” as they involve a lot of “short-term money in the market right now, trading in rapid-fire fashion.”  

Their volatility makes a fruit fly’s flight path seem staid. Oil has soared to a near-record $103 per barrel, yet two years ago went for $18. Gold, a time-honored refuge in troubled spells, hit $1,780 in 2012 amid worries over European defaults. Then with the crisis resolved, the metal fell to $1,060 in 2015, and in today’s fraught climate has zoomed back up to $1,854.

Keep an adequate cash stash

You never know when an emergency can crop up, one that will force you to liquidate precious investments in a rotten market. In an era like this, retirees have a similar problem. They must, by law, withdraw part of their tax-sheltered investments each year, a mandate called a required minimum distribution, or RMD. Result: promising holdings are sold at a low level and can’t help investors in the future.

That’s why financial planners suggest keeping a chunk of your nest egg in cash, perhaps 5%. When you suddenly need the money, your long-term assets don’t get sapped.

Nevertheless, such as tactic doesn’t mean you have to put up with the minuscule interest that banks pay. Advisor Daniel Crimmins says to shop around and put your cash in online lenders that offer more for savings accounts and certificates of deposit, and enjoy the added security of being federally insured. Barclays, for instance, has an online savings vehicle paying 0.7%, per Bankrate.com.

An easy way to find the best payers, says Crimmins, is to use a provider like maxmyinterest.com. This service moves the money each month to different online saving accounts to capture the best interest rates. “The additional interest more than offsets the minor cost of the site,” Crimmins says. The fee is 0.02% per quarter.

Guru Buffett puts enormous store in a having a good financial plan, both to survive the stormy times and benefit from the sunny days. He wrote in a shareholder letter, “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold.”