Managing Your Portfolio
Some managers prefer to add flair to portfolio management by taking unnecessary risks. That is not the approach discussed here. This approach involves using time-tested investment principles to manage your portfolio, supported by a team that purposefully applies continuous monitoring, rebalancing and tax management. This is done with significant discipline—regardless of market, economic or political news.
On the surface, this approach may sound boring—but with investing, this strategy can potentially improve your outcomes. It isn’t about “buy-and-forget.” Rather, this approach reduce the emotional and irrational hubris in portfolio decisions.
Managing the Emotions of Investing
As you start your investment journey with your advisor, you’ll likely feel excited for the future. As markets oscillate, however, we know many investors experience emotional cycles. Even the best investment strategy is moot without the discipline and conviction to stay invested through rough market patches.
That’s why good investment outcomes come from marrying a good strategy with predictable behavior. This is done to anticipate some of the inherent emotions—from excitement to fear to relief—coming from market cycles that can otherwise affect better decisions.
The Roller Coaster of Investor Emotions
Preparing for the Rough Patches
A good start to the investment journey may involve setting an Investment Policy Statement that will guide how to respond to different market environments. Because, as history shows us, market declines are not uncommon.
Despite the frequency of market hiccups, a long-term perspective highlights the potential benefit of staying invested. Plan for market declines, because it is known that, on average:
- One in every three months, stock markets lose value
- Every eighteen months, stock markets decline by 10 percent or more, which is generally considered a market correction
- Every three to four years, stock markets decline by 20 percent or more, which is generally considered a bear market
Stick to the evidence. Don’t make changes to your portfolio based on economic, political or societal events. These events matter, but your portfolio should already be prepared for their shocks. It’s part of the Evidence-Driven Investing™ strategy and another reason for diversification—to help manage for and withstand short-term rough patches, keeping you on track to meet your long-term goals.
Disclosure
Chart provided by Dimensional Fund Advisors. The latest version can be found at https://www.dimensional.com/us-en/insights/market-returns-through-a-century-of-recessions.
Returns are presented in US dollars. Stock returns represented by US market return, provided by Ken French Data Library. This value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before, and excludes American depositary receipts.
The growth of wealth shows the growth of a hypothetical investment of $100 in the US stocks from July 1926 through December 2022. Data presented in the Growth of Wealth chart is hypothetical and assumes reinvestment of dividends and capital gains and assumes no transaction costs or taxes.
For illustrative purposes only. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. The indices do not represent results of actual trading. Performance is historical and does not guarantee future results.
Gross Domestic Product (GDP) based on quarterly data from the US Bureau of Economic Analysis; quarterly data not available prior to 1947. Percentage change in GDP based on business cycle peak to trough quarter as reported by National Bureau of Economic Research (NBER).
Industrial Production, Inflation, and Unemployment based on monthly data from Federal Reserve Bank of St. Louis (FRED); Unemployment data not reported prior to 1929.
Information from sources deemed reliable, but its accuracy cannot be guaranteed.
Keeping Your Portfolio in Balance—So You Can Focus on What Matters
Markets move every day–that’s expected. Your advisor’s job is to monitor your portfolio year-round to ensure that it stays in-line with your tolerance for risk.
- As your portfolio moves out of balance, you’ll see them sell some of what’s done well and buy some of what’s done poorly.
- This is called rebalancing, and it enforces a discipline of buying low and selling high.
- If stocks have done well and have grown over pre-defined target values, they may sell stocks and buy bonds to keep your overall portfolio risk aligned.
Discover how rebalancing can manage risk.
The Process of Rebalancing
Rebalancing to Manage Risk
Stocks tend to grow faster than bonds, so left unchecked your portfolio can gravitate towards having proportionally more money invested in companies than agreed to in the context of your Investment Policy Statement. Over time, this can add up and increase risk. Without rebalancing, an increasing allocation to stocks may expose you to bigger losses during market downturns.
Disclosure
Source: Ken French Data Library, Morningstar Direct 2022.
The chart shows the allocation to stocks for two portfolios to demonstrate that, over time, not reblaancing can lead to having relatively more money invested in stocks than originally targeted. Both portfolios start with the same allocation with 36% in U.S. Stocks, 18% in International Stocks, 6% in Emerging Markets Stocks, and 40% in bonds. The Portfolio with No Rebalancing is not rebalanced over the entire 30-year period. The Portfolio with Rebalancing follows a rebalancing rule where all portfolio asset classes are rebalanced to the target allocation when either major asset class (stocks or bonds) deviates more than 5% away from the target weight.
U.S. Stock returns are represented by the total U.S. market return, from the Ken French Data Library. International Stocks are represented by the total developed international market, from the Ken French Data Library. Emerging Market Stock returns are represented by the total emerging market, from the Ken French Data Library. Intermediate Government Bonds are represented by the Ibbotson Associates U.S. Intermediate Government Total Return Index Index from the Stocks, Bonds, Bills, and Inflation (SBBI) data, from Morningstar.
Turning Losses into Tax Breaks
Sometimes investments lose money. In fact, some may be worth less than what you bought them for. Yet, these can be used to help offset gains and limit taxes. This is known as tax-loss harvesting and its benefits are key:
- Identifies and replaces losing assets
- Locks in losses to offset taxable gains
- Keeps the portfolio in-line with targeted allocation
- Can reduce overall tax burden
Combine Gains
With Losses
Reduce or Eliminate Tax Bill
See how tax-loss harvesting adds up during volatile markets.
The Silver-Lining to Market Volatility
During volatile markets, investments may experience severe turbulence, even losses. When this happens, an advisor may use Tax-Loss Harvesting to sell holdings trading at a loss, replacing them with similar but not identical investments. The losses on these trades can be used to offset other capital gains—potentially reducing either current or future tax bills.
Illustrated here, this can result in higher tax breaks during periods of market downturn, reducing some of the impact of volatile markets. This can be done across stocks, bonds and alternatives.
Hypothetical Tax Break Scenario
| Taxes | Initial Investment | Investment declines 20% | Investment gains 40% | Balance | Cost Basis | Tax Offsets | |||
|---|---|---|---|---|---|---|---|---|---|
| No Tax Loss Harvesting | $100,000 | → | $80,000 | → | $112,000 | $112,000 | $100,000 | $0 | |
| With Tax Loss Harvesting | $100,000 | → | $80,000 | → | $112,000 | $112,000 | $80,000 | $20,000 | |
|
↑ ↓ Tax Loss Harvest Sell the initial fund Realize $20,000 Capital Loss Buy a similar fund |
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Changing Your Portfolio as Your Life Changes
Life isn’t linear. That’s why monitoring your portfolio should be combined with reviewing your plan and financial goals.
Based on your circumstances, the likelihood you will be able to meet and exceed your goals may change. As a result, an advisor may recommend adjustments, such as saving and spending changes, to maintain a healthy probability of future success.
As your situation changes and your goals evolve, it is important to evaluate the impact on your plan.
See How Different Life Changes Can Affect the Probability of a Successful Outcome
Disclosure
General Assumptions: $3 million initial portfolio. Hypothetical clients are age 60 and live through the end of their age 94 (35 years). Portfolio allocation is assumed to be 36% U.S. Total Stock Market, 18% International Total Stock Market, 6% Emerging Markets Total Stock Market, and 40% U.S. Intermediate Government bonds. Portfolio estimate of average annual return is 6.8% , with a 10.8% volatility. Inflation is assumed to be 2.7% per year. Using these assumptions, annual returns are simulated using a Monte Carlo Analysis. The portfolio return for each year is assumed to be independent and the returns are assumed to follow a lognormal distribution. Each scenario assumes no other income besides portfolio withdrawals. Results are based on 10,000 simulations. Success is defined as having at least one dollar left at the conclusion of age 94.
All dollar figures are presented in today’s dollars, and nominal spending will be higher due to inflation adjustments. Spending figures are inclusive of all goals and taxes; actual lifestyle spending would be less after considering taxes on portfolio income, capital gains, and distributions. Portfolios are assumed to be rebalanced to target weights at the beginning of each year. Spending is assumed to be withdrawn at the beginning of each year, prior to the application of portfolio returns for the year.
Scenario saving and spending assumptions:
Retire at 65: $60,000 per year savings from 60-64 (5 years). $120,000 per year total spending from 65-94 (30 years).
Retire 5 Years Earlier: $120,00 per year total spending from 60-94 (35 years).
Work 5 Years Longer: $60,000 per year savings from 60-69 (10 years). $120,000 per year spending from 70-94 (25 years).
Increase Annual Savings: $120,000 per year savings from 60-64 (5 years). $120,000 per year total spending from 65-94 (30 years).
Pay Grandkid’s College: $60,000 per year savings from 60-64 (5 years). $120,000 per year total spending from 65-94 (30 years). From age 70-73 (4 years), increase spending by $100,000 per year for assumed college expenses.
Downsize home: $60,000 per year savings from 60-64 (5 years). $120,000 per year total spending from 65-94 (30 years). At age 65, sell current residence for $1 million and purchase a new residence for $600,000, resulting in a net portfolio deposit of $400,000. Any taxes for the home sale are assumed to be covered by the annual spending.
Buy a vacation home: $60,000 per year savings from 60-64 (5 years). $120,000 per year total spending from 65-94 (30 years). At age 65, purchase a new residence for $600,000.
A Probability of Success is based on a Monte Carlo Simulation. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Monte Carlo simulations are used to show how variations in rates of return each year can affect your plan results. A plan includes information about your assets, financial goals, and personal situation, as well as assumptions regarding the projected inflation rate and the projected return and volatility for various asset classes. A Monte Carlo simulation calculates the probability of success of a plan by running it many times, each time using a different sequence of returns. Some sequences of returns will give you better results, and some will give you worse results. These multiple trials provide a range of possible results, some successful (you would have met all your goals) and some unsuccessful (you would not have met all your goals). Analogously, the percentage of trials that were unsuccessful is the Probability of Failure.
Managing Your Financial Future
An advisor using Evidence-Driven Investing™ will constantly study the financial landscape, the economic drivers and market events that make an impact—keeping you informed at every step.
They won’t try to outsmart the market using tactical shifts or other trendy strategies. Relying on research, they will design portfolios to be resilient to a variety of market environments. And the initial portfolio is just the beginning of your journey together. They will work with you to constantly align your plan to your portfolio, using your Investment Policy Statement as a roadmap.
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