“Are you recommending any changes to my investment portfolio given all the recent market turmoil?”
This is a question we frequently receive from clients during the past few weeks. Usually, they are referring to reducing their stock market exposure or “getting out until the dust settles”.
As financial advisors, part of our job is to expect the unexpected. No one knows what the future holds and history shows capital markets can change directions quickly with little notice. Panic and reacting emotionally will likely lead to poor investment decisions.
It is important to be prepared and have a plan before markets decline as they have in recent weeks. For your investment portfolio, this includes setting up a target allocation for the right mix of stocks vs bonds. This is a decision that takes into consideration a number of factors including your age, proximity to retirement, risk tolerance, spending needs, etc.
During periods of market volatility, investment accounts can quickly drift from their original target allocation. Lately, this is due to the sharp decline in the global stock markets.
Perhaps a quick example would be helpful.
Let’s assume you are retired, and we have jointly determined you should have 50% of your investments in stocks and the other 50% in high-quality bonds.
It is likely the past few weeks have caused your allocation to drift down towards 40% stocks and 60% bonds. This is where our rebalancing discipline gets activated and we sell bonds to buy stocks to get the portfolio back to 50/50.
It may seem counterintuitive to buy stocks as they are falling but it is a proven strategy that can help manage risk and may lead to superior performance.
The same principle applies during a surging bull market. If the same portfolio of 50% stocks drifts above 55%, our discipline is activated, and we sell stocks to buy bonds.
It is only in hindsight that we can determine market peaks and bottoms. Our rebalancing discipline helps ensure that we will maintain the proper amount of risk for each client given their unique circumstance.
There are a couple of other ways an investor can rebalance their portfolio. Many retirees take money out every month from their retirement accounts. Revisiting their target allocations on a more regular basis helps maintain the proper risk and an even more constant portfolio balance.
The same is true for those saving and investing on a more regular basis in their 401(k) plan. Most retirement plan providers allow investors to set up target allocation percentages. New contributions are automatically invested based on these targets thus maintaining an even more constant balance.
Another technique we often employ is labeled “tax loss harvesting.” It’s never enjoyable to take a loss but tax-loss harvesting enables smart investors to realize losses now and somewhere in the future utilize those losses to offset future long-term capital gains.
There are a number of considerations to be aware of before making tax-loss harvesting decisions. Be aware of the wash-sale rule which says if an identical or substantially identical asset is purchased within a 30—day period (before or after) an asset is sold for a loss, the loss may be disallowed. It is always best to consult your tax advisor when implementing this strategy.
Having a rebalancing discipline can be critically important to long-term investment success. It sounds reassuring to “sell out until the dust settles” but no one rings a bell at the market bottom. A better strategy is to have a plan before things get ugly and have the courage and patience to stick with your plan during challenging times.