The first four months of 2022 so far have taken investors along for quite the ride. Thanks to record-high inflation in the US, rising interest rates, and geopolitical conflicts, many investors may feel uncertain about where they stand with their portfolio and some may ask: What are my options? Below I lay out my five responses to this question depending on the investor.
Option #1: Move to Cash – For investors who are unable to stomach the uncertainty around market volatility, one option would be to move to cash. However, by moving to cash you may be decreasing your expected return moving forward. Additionally, reacting emotionally and moving to the sidelines could be detrimental to portfolio performance as you may miss out on some of the best performing days. See Exhibit #1 below for an example of the cost of missing the best performing days of the S&P 500.
Option #2: Rebalance – Our clients work with us to develop a well-thought-out investment plan that will help them achieve their goals. One piece of putting together an investment plan may be setting a target asset allocation. We are working on-behalf of each client to rebalance during periods of market volatility to ensure risk and return preferences are being met and target asset allocation is in line. During periods of relative equity underperformance, we are selling fixed income and buying into equities to keep their portfolio in line with their target asset allocation.
Option #3: Tax Loss Harvest – During market downturns, clients may work with us to manage tax liabilities through loss harvesting opportunities. Certain clients may choose to sell to realize capital losses, which they may use to offset current or expected future capital gains. An effective method of tax loss harvesting, where a client goes directly from one fund to another and the transaction does not settle in cash, is an exchange transaction. Exchange transactions involve a sale out of one portfolio and a simultaneous purchase into another portfolio (must be within fund family) that generally only incurs one ticket charge. Exchange transactions are treated as a redemption and purchase and in most circumstances are executed on the same day which can help minimize the amount of time you are not invested in the market.
Option #4: Stay Invested – To potentially enjoy the benefits of higher expected returns, investors should be willing to accept increased uncertainty. A key part of a good long-term investment experience is being able to stay with your investment philosophy, even during tough times. A well-thought-out, transparent investment approach can help people be better prepared to face uncertainty and may improve their ability to stick with their plan, tune out the noise, and potentially capture the long-term returns the capital markets have historically provided. See Exhibit #2 for an illustration of this.
Option #5:Invest Surplus Cash – During market downturns, some clients have excess cash reserves, or excess fixed income in their portfolio. Investors with excess cash or fixed income, and most importantly a long-term time horizon (see Exhibit #2 below), can buy into the market at a discount from the beginning of the year. But most importantly, our clients should not make decisions or speculate based on the short-term performance of the market.
The Cost of Trying to Time the Market – The impact of missing just a few of the market’s best days can be profound. Staying invested and focused on the long term helps ensure that you’re in a position to capture what the market has to offer.
Exhibit #1:
Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
The Capital Markets Have Rewarded Long-Term Investors– The markets represent capitalism at work in the economy—and historically, free markets have provided a long-term return that has more than offset inflation. The data illustrates the beneficial role of stocks in creating real wealth over time. A key point is that not all stocks or bonds are the same. For example, consider the performance of US small cap stocks vs. large cap stocks over this time period and the cumulative difference in $1 invested in each index in 1926. Keep in mind that there’s risk and uncertainty in the markets. Historical results may not be repeated in the future. Nevertheless, the market is constantly pricing securities to reflect a positive expected return going forward. Otherwise, people would not invest their capital.
Exhibit #2:
Past performance, including hypothetical performance, is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
Advisory services are offered by Forward Financial LLC an Investment Advisor in the State of Illinois.
All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication or future results. Moreover, this material has been derived from sources believed to be reliable but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed.
