This year has been a testament to financial markets’ remarkable ability to look past the noise.
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Throughout 2025, investors faced a barrage of potential shocks, from escalating tariff threats to questions over the Fed’s independence to renewed geopolitical tensions and the stubborn pulse of inflation. Yet, in classic bull market fashion, equities have largely shrugged it all off. Each new “crisis” has been swiftly discounted, and risk appetite has continued to build.
The result: a market that keeps grinding higher, defying skeptics and flirting with the rare feat of delivering a third straight year of 20% gains in the S&P 500. After an improbable climb, equities now sit at elevated valuations, with forward earnings suggesting low or very low returns in the years ahead. Meanwhile, the specter of resurgent inflation continues to cast a shadow over bonds, threatening to erode real yields and test fixed-income resilience.
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For advisors, this is a moment to revisit portfolio construction to build in contingencies, stress-test assumptions and ensure clients are prepared for volatility across both major asset classes.
In my book, “The Behavioral Portfolio: Managing Portfolios and Investor Behavior in a Complex Economy,” published last spring, I issued a call to advisors to embrace their role as investors’ chief risk officer. As we head into 2026, with valuations stretched and government debts high, assuming that role may be more important than ever.
Here are three explicit strategies to prepare your portfolios and your clients for the challenges ahead.
Rethink the safety of bonds
Advisors often view bonds as the anchor of portfolio stability, but that confidence may be misplaced in the coming year. Why worry now? In a word, debt. With U.S. debt already near unsustainable levels, the fiscal buffer available to help avert the next recession is largely absent or, if deployed, has the potential to amplify debt and bond issues even further.
Global debt across governments, corporations and households now stands at near record levels, with U.S. net debt to GDP near 100%. Once a country’s debt surpasses roughly 90% of GDP, global macro investor Ray Dalio and others warn that the risk of inflation or debasement accelerates. For investors, the takeaway is clear: Bonds aren’t risk-free — they’re rate, credit and policy dependent.
To meet the current moment, I recommend adaptive fixed-income strategies designed to earn yields above inflation and limit losses as rates rise. Laddering maturities (buying bonds of varying durations and reinvesting maturing issues at higher yields as rates climb) is a simple technique that can cushion portfolios from interest rate shocks. Unconstrained bond strategies (flexible mandates that can rotate among Treasuries, credit, floating-rate and high-yield bonds) can pivot defensively when risk spreads widen and opportunistically when yields normalize.
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In essence, investors should abandon the buy-and-hold-the-aggregate-index mentality. Fixed income should now act as an active risk manager, not a static allocation. As global debt continues to stretch, passive bond funds may remain particularly exposed to correlated drawdowns.
Acknowledge heightened valuations and hedge
In the 2008 financial crisis, stocks fell for 16 months and then rallied fiercely off of the bottom. But in the Great Depression of 1929, bear markets persisted for 13 years. During that time, as I demonstrate in my book, a 60/40 balanced portfolio drew down 67% over nearly three years, rallied, and then entered a second five-year bear market. Losses at that level are unnavigable for many clients — and may prove to be for many wealth management firms.
To address the possibility of markets entering a correction — or worse — in 2026, advisors and investors should consider integrating hedged equity funds or ETFs that seek to limit clients’ downside participation.
Let clients in on the plan
Will markets turn lower next year? No one knows. But it’s hard to argue with the need to address down-market contingencies as we approach the end of 2025.
Recession-proofing a portfolio for 2026 means accepting that the next downturn may not look like the last. High sovereign debt, persistent inflation and waning policy flexibility point to a new era of risk — one where both bonds and stocks can fall in tandem.
But it’s not enough to make portfolio changes. Advisors must explicitly communicate to investors how these changes are designed to address adverse markets before they occur. Doing so can lead to significant improvements in their peace of mind when markets eventually turn lower.
