By Guest commentary Thursday, December 31st, 2020

By Tracie McMillion

The year 2020 had more than its fair share of uncertainties—from the market sell-off in March to sporadic periods of market volatility. As we turn the calendar year, it is now time for investors to focus on the road ahead. Here are five actions investors should consider in 2021:

1. Hold the right amount of cash. Investors could be forgiven for holding on to their cash in 2020, but they have not been rewarded for doing so. One of the most frequent questions we received during the COVID-19 crisis in March, and then again leading into the election, was: Should investors sell their assets and hold cash?

We steadfastly guided investors to stay fully invested; holding only enough cash for an emergency fund and for trading opportunities. Our research shows that often the best trading days have fallen among the worst days, and missing even the 10 best trading days over the last 10 years cut annualized returns by more than half in a globally diversified portfolio.

Many investors have held too much cash for too long, and the challenge is to get that cash invested as we turn the corner into 2021. Our suggestion is to take a disciplined approach to investing cash through a dollar cost averaging program. This means breaking the cash into equal parts and investing it over a specified period of time.

2. Selectively increase risk. Taking on more risk at the portfolio level may benefit investors as the Federal Reserve supports the financial system through ultra-low interest rates and as underlying economic conditions improve. We suggest reducing exposure to lower-risk fixed income investments to fund overweights to higher-risk assets like U.S. equities and commodities.

We are currently unfavorable on only one equity asset class: developed market equity, as that region struggles to make economic headway amid resurging virus cases and Brexit complications. We have recently upgraded our views on U.S. small-cap and emerging market equities, as global economic conditions stabilize and the promise of an effective COVID-19 vaccine is on the near horizon.

3. Consider higher-quality, growth-oriented sectors. Our preference for higher-quality assets with stable profitability and relatively low financial leverage is reflected in our more favorable ratings for U.S. assets over international assets. It is also expressed in our heavier tactical allocations to U.S. large and mid-cap equities relative to small caps.

Our favorite sectors also exhibit the potential for higher-quality earnings and the ability to grow earnings. These include the information technology, consumer discretionary, communication services and healthcare sectors. We also see opportunities in cyclical sectors and have recently upgraded materials and industrials.

4. Diversify income sources. Yields on government bonds around the world are low and are likely to stay that way for an extended time. This makes it challenging for some investors to earn sufficient income to fund their expenses.

In addition to a core allocation of high-quality fixed income for diversification purposes, we think investors should consider broadening their sources of income to include high-yield bonds, emerging market debt, preferred stocks and high dividend equities. These asset classes typically exhibit more volatility risk than high-quality bonds, but the increased income may be worth the tradeoff within a portion of a portfolio’s allocation.

5. Be proactive, not reactive. Investors who have an investment plan going into a market disruption can be more proactive when volatility strikes. Including assets in a portfolio to absorb the shock of a downturn and provide funds for rebalancing, such as fixed-income assets, helps investors take thoughtful action during downturns. Setting target allocations in relation to expected levels of risk and return ahead of volatility can help with trading decisions during more volatile times.

Also, consider regularly rebalancing portfolio allocations back to target allocations in an effort to manage risk. In 2020, taking a disciplined approach to asset allocation generally meant higher returns for investors than reacting to the approaching bear market by selling equities. In fact, investors who sold their equity assets in mid-March missed the strong rebound and may be still underwater. It is not too late to develop a plan to stay disciplined through any bouts of market volatility in 2021 and beyond.

• Tracie McMillion is the head of global asset allocation strategy at the Wells Fargo Investment Institute.