Recently, the actions of short-term traders have created many attractive opportunities for advisory clients amid a volatile market.
For example, international developed-country stocks, which are already relatively attractive, compared with U.S. stocks, have gotten even cheaper over the past year. So have emerging-market equities.
Here are a few actionable ideas:
1. Tax loss harvesting. Even in a world of low returns, reducing clients’ tax bill is one way to add value,
year after year.
Tax loss harvesting strategies are designed to execute a continuing, customized plan to limit gains and harvest losses. Harvested losses could be used to offset investment gains and to a limited extent earned income.
Active-tax-indexing portfolios can be built with individual stocks and can be benchmarked to most standard market indexes. When using separately managed accounts, active-tax-indexing portfolios can also be constrained to exclude individual sectors or securities, which is especially helpful for clients with large positions in particular stocks or industries.
With individual stocks, it is possible to find an alternative stock to replace the ones with losses. In addition to maintaining diversified index-like exposures, such harvesting also avoids the wash sales.
2. Opportunistic rebalancing. Even during times when the broad equity or bond market as a whole is
flat, one or more market segments can be down substantially. For example, during the turbulence in January, U.S. large-cap stocks were down about 6% from a year earlier; large-cap international stocks (MSCI EAFE index) were down more than 15%; and emerging-market equities (MSCI Emerging Markets Index) were down over 25%, and this relative disparity continues. For investors who happen to be underweight international developed or emerging-market stocks or overweight U.S. large-caps, this is a great time to rebalance.
Moreover, investors that are underwater in their large-caps can rebalance and realize a tax loss.
3. Diversifying and globalizing. Diversified portfolios that include multiple asset classes and currencies
are likely to perform better during future bouts of volatility. For example, buying stocks overseas gives investors the opportunity to diversify their currency exposure.
Although such diversification worked against dollar-based investors in 2014 and 2015 as the dollar appreciated against major world currencies, going forward foreign stocks may reward equity investors. If dollar appreciation comes to an end, the currency markets could prove trickier for U.S.-based investors.
One way to deal with currency volatility is by choosing a portfolio whose currency exposure is unhedged.
Rather than becoming unnerved by market volatility, long-term investors can benefit from it by using a temporary mispricings to reposition their portfolios into more optimal long-term allocations.
This story is part of a 30-30 series on ways to build a better portfolio.