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If you thought stocks and bonds usually move independently, you're not wrong. It's one of the reasons they complement each other in financial portfolios — bonds can provide stability and balance out the volatility of stocks.
And yet, that didn’t happen in 2022, the worst year for bonds on record in a century. Here's why experts thought this happened and what consumers should do to weather the storm.
Inflation and rising interest rates affected stocks and bonds
Many factors affect stock and bond markets. Economist Anessa Custovic, chief investment officer for Cardinal Retirement Planning, suggests when we see correlations between assets — meaning when stocks, bonds, gold, real estate or other investments move in the same direction — it's due to related economic trends.
In this case, Custovic — based out of Chapel Hill, North Carolina — says consumers felt the pain of top-down macroeconomic forces such as a lingering pandemic, supply-chain issues and geopolitical crises. Not to mention, inflation highs not seen for 40 years.
The U.S. central bank, known as the Federal Reserve, wants to get inflation under control, and one of the tools they have to do that is interest rates. By raising interest rates, the Federal Reserve made borrowing more costly to slow economic growth and rein in inflation.
This probably felt different and uncomfortable because it was. "Usually, we don't have rate hikes while financial conditions are already tightening and uncertainty is happening," says Custovic.
How interest rate hikes influenced stock prices in 2022
Rising interest rates directly caused stock and bond prices to fall in 2022.
Interest rates affect a company's capital and earnings in many ways, says Damian Pardo, a certified financial planner and city commissioner in Miami, Florida.
First, companies made less. A company's debt probably became more expensive in a rising interest rate environment and ate into earnings. And with earnings lower, their share price could fall.
Second, people had less. If consumers had less money available due to inflation, says Pardo, "earnings are probably going to get hit because [consumers] may not be buying your product the way they were buying it the year before." This could look like consumers putting off the next tire, phone, fridge or vacation purchase because each paycheck is buying less than it did before.
Third, bad news can feed off itself. As financial analysts reported on decreased consumer spending and the increasing cost of capital, word spread, stock expectations changed, and some people rushed to sell.
"All of that puts pressure on the price of stock," says Pardo.
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Why rising interest rates pushed bond prices down, too
Bond interest rates are usually set upon purchasing a bond. When rates rise, new bonds with higher rates are issued and become more desirable than bonds with lower rates. As a result, the value of the bonds people already own with lower rates will fall. Falling bond prices are of most immediate concern to bond owners looking to sell in the short term.
However, Pardo stresses that it's essential not to panic. If you own high-quality bonds and hold them to maturity, he says, you will likely still receive your principal and yield.
But if you must sell sooner rather than later, remember the following strategies.
How to manage your portfolio during a downturn
Bear markets and falling prices don't last forever. All are 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 possible.
Consider the following four strategies for adjusting your financial plan and mindset during tough times.
1. Reflect on whether your financial goal has any flexibility.
Do you need to access this money? If you don't need the money right now, sit tight.
2. Lean on excess cash reserves first if you have them.
A cash reserve is an essential component of any financial portfolio; it's a way to hold resources in an easy-to-access spot in an emergency.
If you have it, says Pardo, dipping into it is an option. For example, if your emergency fund contains more than six months' worth of living expenses, you could use three months of emergency funds while conserving the rest.
Spending a limited amount of cash in a way that still preserves your emergency fund overall can make strategic sense. Using cash first, instead of selling off other assets, will allow you to remain invested, ideally long enough to benefit from an eventual recovery.
3. As a last resort, strategically consider what assets to cash out first.
"The way you take your money out of the portfolio, and when, makes a huge difference on how long this money is going to last," says Custovic. "If you need to withdraw funds, pull them first from the assets that have a positive return or have lost the least amount of money."
4. Ask for help. If this feels complicated, that's because it is.
A certified financial planner or advisor can help you weigh your values, timeline and goals and create a financial plan that works for you.
