After more than a decade of US economic growth, a record-long bull market in stocks, and record-low market volatility, last week we hit records in the other direction: sky-high volatility, historic one-week drop in stock prices, and an economy that could slow significantly in the first half of 2020.
Given all the good times — including a 30%-plus gain in the S&P 500 in 2019 — it is not surprising that a lot of investors have forgotten the basics of good hygiene, so to speak, when it comes to their portfolios. These basics are the equivalent of washing your hands with soap regularly and sneezing into your handkerchief/elbow. Not very exciting, but good practice at all times. What are those basics for portfolios? Read on:
#1. Stay Diversified. Last week, high-quality bonds gained in value, especially US Treasuries, as stock markets around the globe kept falling. For portfolios with a significant allocation to high-quality fixed income, the downturn last week was not nearly as scary. In fact, through February, high-quality US bonds were up nearly 4% (Barclays Aggregate Index) vs. an 8% drop for the S&P 500. This type of offset makes it more likely to do good practice #2 below.
BTW: By diversified, we mean your entire asset base viewed as a whole. If, for example, you have a variety of stock options through your job, count those in. Also, real estate. What level of diversification works best for you is based on a lot of factors unique to you, so there is no magic number. The level of diversification that works best for you within financials assets/real assets/cash is something we work closely with you to determine.
#2. Take the Long View. Typically, we have a 10-year investment outlook and try to manage portfolios to provide each client with enough cash and ongoing income for their needs in the intermediate term. The comfort that comes from knowing you have enough cash set aside to weather a downturn and that your portfolio is still generating income to replenish cash is key. It allows you to have enough confidence to stay invested through turbulence, such as that we are seeing now, and not be tempted to lock in a loss and potentially miss a rebound. It is nearly impossible to time the markets consistently. And that is especially the case when the threat is something like a new virus, whose ultimate duration and impact remains unknown.
We get it. When prices start falling significantly, the temptation was (and is) not to rebalance but to SELL ALL. Before you do that, though, realize that markets moves can happen quickly in either direction, and the danger of getting whipsawed is great. Also, if you sell in taxable accounts, you will probably owe sizable capital gains taxes all at once.
#3. Rebalance. With the runup in stocks, especially in 2019, many people ended up having much more in equities than they realized. While portfolios should be rebalanced on a regular basis, this is especially valuable during downturns. Rebalancing then “forces” you to do some opportunistic buying (and selling), so you’re better positioned to benefit from the relatively few (and hard to predict) days when stocks really put on gains. Here at LNWM, we also help your overall tax situation by tax-loss harvesting, a fancy way of saying we look for opportunities to sell some securities at a loss in order to offset capital gains taxes.
A fit portfolio. If your portfolio truly fits your finances and risk tolerance – something we strive for here at LNWM – it can make it through a market downturn and be positioned to thrive once that is over. This requires attaining a suitable balance among stocks and bonds, international vs. domestic, and sometimes alternative and private market assets to ramp up diversification and potentially soften downturns. You are then likely to feel less anxious during times of heightened market volatility. Why? Because you know your portfolio is designed to handle bad times, as well as good.