If you’re a regular reader, you know that we strongly encourage DIY investors to allocate the assets in their portfolios to reflect both breadth across markets and depth within markets. This is the strategy we use when investing on behalf of our own clients, and we have found that it offers a good balance of driving growth while minimizing volatility – one of the many risk management techniques we employ at Atlantic Capital Management.
Market dynamics being what they are, however, it’s important to regularly evaluate the structure of a portfolio and rebalance the asset allocation to take life and market changes into account. For example, emerging markets have been sliding over the past 6 months, warranting a hard look at what portion of your portfolio should be invested in that area, if any. Similarly, life changes, like pending retirement or buying a home, that impact the time horizon of your expected returns should also drive examination of your portfolio and/or adjusting your risk tolerance.
Following are a couple of milestones you can use for gauging whether it’s time to look at rebalancing the mix of assets or investment products that make up your portfolio:
Risk Tolerance and Time Horizon: If you find that your time horizon has been shortened by a life event or other unplanned-for situation, you will have to include some evaluation of your appetite for risk into the rebalancing equation. Investors with relatively stable, long-term goals can rebalance less often than investors who need more flexibility and liquidity. Undertaking a rebalancing should always begin with an honest assessment of your tolerance for risk.
Tax Status: Rebalancing a portfolio sometimes involves selling off portions of it, particularly equities. This, unfortunately, makes you subject to capital gains taxes in most cases. If your portfolio is heavily invested in taxable accounts, resist the urge to frequently rebalance unless you can stomach the tax consequences that come with it. The opposite is true if most of your investments are held in tax-sheltered accounts. It’s a good idea to consult a tax professional to understand the implications before moving a lot of money in and out of taxable accounts.
Transaction Costs: In general, most savvy investors aim for the lowest possible transaction costs, both in long-term and short-term scenarios. Paying a broker or advisor who takes a commission on the sale of assets makes frequent rebalancing less appealing, for many of the same reasons related to tax status. Even if you buy and sell on your own, pay attention to the overall transaction costs you incur when moving in and out of asset classes. Those fees can really add up and eat into your gains over the long-term. Try to avoid the double-whammy of taxes AND transaction costs by rebalancing only when it’s favorable. Studies have shown that barring any major change in personal or financial circumstances, yearly rebalance is sufficient.
Exchange-traded funds, or ETFs, are a popular and effective investment product utilized by many individual and institutional investors. Generally speaking, an ETF fund models the performance of a particular market or market sector index; when you invest in an ETF, your money grows or diminishes according to the performance of the index as a whole. ETFs run the gamut from mild to wild. For example, you can invest in ETFs which model a broad U.S. stock market such as the S&P 500 or the DJIA; you can also find ETFs which model foreign stock markets, like emerging market stocks. There are also indices which mirror other markets such as commodities, real estate, bonds or currency. ETFs provide a easy way to diversify at low cost with greater tax efficiency than you would find in the traditional mutual fund. This is why ETFs a popular choice for many DIY investors.
Because you are investing in a basket of securities and not individual securities ETFs are considered a passively managed investment. This approach differs from the traditional actively managed fund in the sense that the securities in a mutual fund are actively managed throwing off taxable activity. Passively-managed funds are essentially binary: you are either “all in” or “all out.”
The portfolios we build for our clients often include ETFs for cost savings and diversification. Our experience has shown that ETFs are an excellent choice for portfolios built for “the long run,” and that they complement our actively-managed funds nicely. (Our investment strategy is generally “active.”)
If you’re considering making ETFs a part of your DIY investment strategy, we strongly recommend that you avoid tying up too much of your portfolio in passive investments. There are literally thousands of ETFs available, and the “point and click” ease with which you can buy into them makes it easy to overweight a portfolio with passivity. Incorporating some passive investments in a generally active portfolio is a solid strategy for most DIYers. Leave yourself some room to move pieces of your portfolio around if you need to, without the pressure of being “all in” on passive investments.
Having said that, we’re not advocates of “timing the market” or being impulsively active; we believe that the truest course to financial security is a long-term one. But we review our clients’ portfolios regularly and actively make adjustments based on their goals and tolerance for risk. Including ETFs in the portfolio mix gives us the flexibility to make adaptations with both the short term and the long haul in mind while still preserving the focus on diverse, low-cost investments. This is an approach to asset allocation that works well for us, and translates equally well for most individual or DIY portfolios. It’s a good long-term strategy; recent research from Morningstar indicates that on average, active funds outperform passive funds in market downturns, and passive funds outperform active funds when the markets are on the upswing. Funding a diverse portfolio never goes out of style.
While it still feels very much like winter here in the Northeast, weather forecasters and the calendar assure us that Spring will, indeed, get here soon. With the arrival of the first robin in the front yard also comes a day that many Americans dread, or at the very least loathe: April 15, the deadline for filing Federal and state taxes. Tax season can be stressful under even the best of circumstances. Adding to the unease for many people is the possibility of an arbitrary investigation of their tax returns, known as an audit, that the IRS sometimes performs. While most Americans will fortunately never have to deal with the tax man showing up at their door, there are some well-established red flags that make certain returns more likely to be audited. I’ve listed 3 of the most common below; your tax professional or accountant can discuss the rest with you. (Don’t have an accountant? Give us a call…we can refer you to one of our many local and national tax attorneys or CPAs.)A quick note: Historically, the IRS audits less than 1% of the tax returns it receives every year. Given the recent scandals, budget cuts and staff eliminations, it’s likely that that percentage will drop for the ~250 million returns the agency receives in 2014. The scenarios I discuss below are the ones that raise the the likelihood your lucky number will be chosen.You might be more likely to face an IRS audit if you:1. Earn a well-above-average income. The median household income in the United States is currently a little over $51,000 per year. If you’re a “one percenter” with an income over $200,000, you are about 3 times more likely than the average person to be audited by the IRS. If you make over $1 million per year, your chances of being audited go up to 1 in 8. Obviously, we’re not going to counsel you to earn less income! But if you’re in a higher income bracket, be aware that you face more scrutiny.2. Claim excessive deductions on Schedule C. The IRS has been cracking down on self-employed taxpayers who over-report deductions on the Sole Proprietorship Profit and Loss form, otherwise known as Schedule C. This is due mostly to “paraprofessionals” like part-time real estate agents, day traders and others reporting rental and trading losses on Schedule C instead of the appropriate forms. We encourage honesty, obviously, but be wary that you might be paying for others’ sins if you are self-employed as a sole proprietor. Word from the wise, there is a fine line between tax avoidance and tax evasion – evasion however is still illegal.3. Take a lot of charitable deductions. Auditors pay close attention to charitable deductions, and they specifically scrutinize how the amount of charity giving or gifting you report stacks up against your income. If there’s a large disparity, your return is more likely to spur unwanted interest. If you do a lot of charitable giving, understand the regulations, and relentlessly document everything.These are just a few examples of the types of issues that can raise the likelihood of an IRS audit. As noted above, we’re happy to share our experience in this area with you, or refer you to a qualified CPA for more information.
As we’ve discussed in previous articles, there is no shortage of investment advice for maximizing portfolio returns using techniques that range from “cutting-edge” to “downright crazy.” Timing the market, chasing high yields, speculating in precious metals…all of these strategies are utilized on a daily basis by DIYers (Do It Yourselfers) and professionals alike in an effort to “beat the markets.” At Atlantic Capital Management, we don’t chase returns with faddish techniques. We advocate a much different solution for our clients and DIYers; think of it as a “base hit” approach vs. a “home run” approach.
Diversify…and stay invested.
It’s that simple. If financial security is your long term goal, stick with an approach that leads to success over the long-run. The foundational principle of this strategy is leaving your money where it is and riding out the inevitable market downturns. This doesn’t mean ignoring reality; it means you (or your investment advisor) should start with the end in mind and make changes to your portfolio that are driven by your long-term goals. The underpinnings of this approach are simple: allocate assets across markets for breadth and within market sectors for depth. This focus on diversification will instill confidence rather than lead to the impulse to “bail out” when things look bleak.
And it’s inevitable that things will look bleak. For example, consider the global financial crisis of 2008. Many people ran for the hills when the markets hit bottom in 2009, either dumping or converting their investments on a large scale. It’s hard to fault this reaction; after all, if it were possible to accurately predict a market’s bottom, most people would be doing it!
Some investors, however, stuck to their long-term focus knowing that their portfolios reflected their need for liquidity, their personal tolerance for risk, and an appropriate time horizon. Investors who structured resilient, diversified portfolios hung on to their positions. The results of this strategy are telling, and fundamental to why we advocate staying invested. According to data from Morningstar, $100,000 invested in the stock market in January 2007 (the beginning of the slide) was worth only $54,000 in February 2009 (the bottom point). Investors who pulled out at the bottom obviously suffered significant declines. More importantly, those who pulled out at the trough and let things cool off for a year and then reinvested ALSO saw a net loss on their investment. Only those investors who stayed invested and rode out the storm with a long term goal in mind saw the value of their investments grow. For those investors, that $100,000 was worth $143,000 at the end of 2013.
As predicted by many market-watchers, the Federal Open Market Committee announced on January 29 that it would continue to cut its monthly bond purchases. Citing the continued moderate expansion of the U.S. economy, Fed Chairman Ben Bernanke moved to trim the bond-buying program (known commonly as “quantitative easing” or “the Fed taper”) from $75 billion per month to $65 billion. Bernanke additionally announced that the Fed’s policy of supporting near-zero short-term interest rates would continue indefinitely. Short-term interest rates, which govern the rates at which financial institutions borrow from one another, have a cumulative effect on all loans; in deciding to keep the federal funds rate target rate between 0% and 0.25%, the Fed reiterated its focus on stimulating the economy through availability of capital.Several things came to mind as I read through the announcement:
At ACM, we’re inclined to follow the Fed’s lead and “stay the course” with our traditional focus on breadth and depth across markets. We’ll certainly be paying attention to the next rounds of tapering as they take place, but for right now, we’re taking it in stride.
As we discussed in last year’s article on the growing increase in life expectancy (“Financial Security for Longer Life Expectancy” ), Americans are living longer. Women in particular are living well past the average life expectancy benchmarks. Recent longevity statistics tell us that women will generally outlive men by 5 to 7 years; the promise of a longer life is even better for those that are married.
Most women of the “Baby Boomer” generation seem to realize that their life expectancy will exceed that of their parents' generation. Less obvious are the financial consequences of extended longevity. Boomer women have embraced living longer, but remarkably few of them have done the kind of retirement planning necessary to address that possibility. Studies indicate that less than one-third of women age 55 or older have enough retirement money to match income projections based on their average life expectancy and beyond.
So, what does all this mean for women in terms of graciously living out this expected and predictable extension of life? Our many years of experience tell us this: having a retirement plan that addresses this scenario is a necessary, and fairly simple, requirement! Here are three suggestions that will help you get off to a good start:
1. Be brave. Not having enough money for later life is a scary thought, and can be emotionally paralyzing. Instead of letting that fear lead to procrastination, take an objective and creative look at your situation. Explore your options…all of them, no matter how daunting or trivial. Simply being aware of the options for reducing your lifestyle can be empowering. For example, you may need to consider “downsizing” out of your family home. Getting through the emotional aspects of this decision is hard. But being brave, and being proactive about the idea of making a change, will help to strengthen feelings of being in control of your financial future.
2. Don't wait. Procrastination isn't an option. The planning and decision-making processes take time. Take one simple step right now: determine how much cash flow your current lifestyle is requiring each month, and make the necessary adjustments to your spending and saving habits with your retirement goals in mind. Get started now. It won't be easier or better or more comfortable if you wait to begin your planning process.