November 29, 2023


Business&Finance Specialists

‘Rebalancing during this pullback is a great idea’: Ask your financial adviser these 6 questions before reacting to stock-market volatility

9 min read

First, consider this general guide on investing: it’s about playing the long game instead of hyperventilating over headlines and doing something drastic, financial advisers say.

Now file that statement under things easier said than done.

Investors, especially newer ones, are getting tested by a convulsive stock market that keeps shedding value while big-picture economic questions loom. When will the heat of decades-high inflation cool? What are the reverberations of Russia’s ongoing invasion of Ukraine? What’s the likelihood of a recession and what does it resemble if and when it arrives?

It’s also easier said than done considering that investors of all sizes are hard-wired to hate racking up losses instead of profit returns, according to the behavioral economics theory of loss aversion.

‘If you stay the course, time will likely be your friend.’

— Bryan Curry, of Bridge the Gap Retirement Planners

Despite some intermittent glimmers of green, it’s been a rocky, ruby-red slide for stock markets this week for the Dow Jones Industrial Average
the S&P 500
and the Nasdaq Composite
The three major indices recovered some ground on Friday after a sea of red earlier this week.

But breathe deep, advisers continue, and remember there can be ways to tweak and alter your investing approach without attempting the impossible by supposedly spotting the best time to hop in and out of markets.

“Rebalancing during this pullback is a great idea,” said Brandon Opre of TrustTree Financial in Huntersville, N.C. and Fort Lauderdale, Fla. It’s something he’s been doing with his clients for about a month now, particularly the ones with brokerage accounts where the tax implications of capital losses make the move a “no-brainer.” (More about that later.)

Rebalancing comes down to three elements, said Trey Bize, of First Allied in Oklahoma City, Ok. Determine stock and bond allocations based on risk tolerance and financial goals. Figure out the holdings on the stocks and bond side. Decide what amount of upward or downward “drift” in holdings’ value to allow before rebalancing, he noted.

Still, Bize added, “Following a ‘system’ is essential, which really isn’t all that easy for most people.”

That’s why MarketWatch asked financial advisers to discuss how investors can review and readjust their portfolios in ways that factor in the current churn of issues while also maintaining long-term goals.

What happens if I keep my money in index funds?

Be prepared for more market bumpiness — and very likely more losses — but then get ready for the bounce to profits at some point, advisers said. “If you stay the course, time will likely be your friend. Depending upon the index, the recovery can be longer or shorter,” said Bryan Curry, of Bridge the Gap Retirement Planners. He called index funds “a great core to a portfolio.”

Pouring money into funds tracking stock market benchmarks are not an end in themselves, said Erika Safran of Safran Wealth Advisors in New York.

‘Investing in index funds is a vehicle for investing, not an investment strategy.’

— Erika Safran of Safran Wealth Advisors in New York

“Investing in index funds is a vehicle for investing, not an investment strategy,” she said. “Your investment strategy will dictate how much you invest in various indexes and this will be the primary impact on portfolio performance. The cost to invest is the next to consider and index funds have lower costs than actively managed funds.”

It’s also important to understand how index funds are built, said Harlan Freeman, of BrightPath Financial in the Chicago, Ill. area. “A problem with many index funds is that many indices are constructed using market cap weightings. That means the largest firms have the biggest allocation in the index. In the case of the S&P 500, that means you are heavily tilted to technology as about 25% of the S&P 500 is invested in technology.”

Other benchmarks, like the MSCI All Country World Index “have only a 20% tilt to technology. An equal weighted S&P 500 fund would have about a 14% allocation to tech,” Freeman noted. “Total portfolio construction matters, and not whether you are in an index fund or otherwise,” he later added.

The Dow is “price-weighted,” meaning a company’s price-per-share determines its weight within the index.

If I don’t put my money in index funds, where should I put it now — and how much?

There’s no one answer to the question, many advisers noted. It’s guided by an investor’s goals, appetite for risk, how long they want their money in the market and other person-by-person variables, they said.

“The case for actively managed mutual funds somewhat increases during periods of market turmoil,” according to Chris Diodato of WELLth Financial Planning in Palm Beach Gardens, Fla.

‘The case for actively managed mutual funds somewhat increases during periods of market turmoil.’

— Chris Diodato of WELLth Financial Planning in Palm Beach Gardens, Fla.

Hypothetically, an actively-managed fund may try reducing risk at a moment like this, Diodato said. “Trying and successfully derisking a portfolio in advance of a market decline, however, are two different things, as many active managers end up causing more harm to the portfolio trying to time the market.”

In Curry’s opinion, it’s not bad to have small positions in individual stocks to possibly beat index performance — but it’s always important to keep portions like a rainy day fund in cash, he said.

One helpful move could be “tilting a portfolio of equities from growth to value,” Freeman said. “If you are patient, small cap, international developed and emerging markets are better valued than are U.S. large cap stocks, so increasing tilt to those categories could be helpful for the longer term and reduce losses as the market continues to adjust.”

How much money should I put in fixed income?

There’s the traditional 60/40 portfolio devoting 60% to stocks and 40% to bonds. The approach has its supporters and critics now, but whatever the allocation, advisers say there are a couple things to remember about fixed income when interest rates are rising.

When interest rates rise, bond prices fall in what’s known as interest rate risk. Bonds with lower interest rates in a person’s portfolio are now in the market alongside newer vintage bonds with higher interest rates —- and that “decrease[s] the appetite for older bonds that pay lower interest,” if an investor had to sell it ahead of maturity, according to FINRA.

But more bonds may give investors some added downside protection if the potential “magnitude” of loss is what’s keeping them up at night, said Jeremy Bohne of Paceline Wealth Management in Boston, Mass.

It’s important to remember that not all bonds are the same, he added. For example, short-term bonds, either governmental or corporate, are regarded as a safer option, he said. Short term means less than two years from issuance to maturity — and that gets back to the idea of confining the amount of time that higher interest rate bonds can compete against those with lower rates, he said.

‘If your objective is avoiding large losses, high yield is not the place to be.’

— Jeremy Bohne of Paceline Wealth Management in Boston, Mass.

I-bonds, which is federal government debt with yields adjusted to the prevailing inflation rate, are certainly an option to consider, Bohne said. People can buy I-bonds with a 9.62% interest through October. One catch is a $10,000 annual limit on purchases, though you can buy another $5,000 with your income tax refund. That may not provide some investors with a lot of room to safely stow parts of their portfolio, Bohne said.   

Then there’s junk, or high-yield bonds, which “tend to behave more like stocks,” he said. Example: debt from Carvana
and Coinbase
fell in the high-yield markets Wednesday after news from Carvana about layoffs and earnings reports from Coinbase showing lower than expected revenue and the loss of 2.2 million crypto traders.

“If your objective is avoiding large losses, high yield is not the place to be,” Bohne said.  

Do I cut my losses and get out of the stock market now?

No, many advisers said — but with some caveats thrown in.

Many people wrongly think they can “forecast the market and know exactly when and for how long the ups and downs will continue,” said Sweta Bhargav of Adviso Wealth in the Greater Philadelphia area. Think about the time costs to research what’s ultimately guesswork on when to exit and re-enter the market, Bhargav said. And think about the financial costs too.

‘The cash held is losing its purchasing power.’

— Sweta Bhargav of Adviso Wealth in the Greater Philadelphia area

It’s been getting cheaper to trade through a brokerage account, but “it’s not entirely free to trade in and out of the market.” And besides, “with inflation above 8%, holding cash on the sidelines, earning less than 1% would not be a smart money move if you don’t know exactly when you’ll get back in the market. The cash held is losing its purchasing power.”

The answer can be yes and no, Safran said. Investors waiting on the sidelines may avoid the downward dips, but they miss the upward swings, she said. “If you absolutely must take action in your portfolio, sell your losers for a tax loss, and buy back similar investments monthly (to avoid wash sale rules) until your allocation is met.”

There are no guarantees in the approach, but Safran said it may “help you manage fear about volatility and loss and gets you invested.”

What should I remember if I want to buy the dip on some stocks?

Start with some humility, said Thomas Duffy of Jersey Shore Financial Advisors. “There is no rule that says the dip you bought was the lowest dip there will be. Be prepared to be wrong,” he said.

See also: Opinion: When is it safe to start buying stocks again? We’re not there yet, but these are the six signs to look for

Also be prepared to ask yourself some questions about the particular stock you are eyeing, said Bohne. “It’s important to consider whether the recent price movement is the result of company specific news or broad-based investor sentiment,” he said.

If it’s company-specific, Bohne said the question becomes whether the company has the power and control to fix its problems and address its challenges. If it’s about share prices getting pulled down in the gloom, that’s a mood outside the company’s control, he said. In that case, “then all investors have to change their view of the market” before the stock price outlook brightens.

How does portfolio rebalancing affect me at tax time next year?

IRAs and 401(k)s are tax-advantaged accounts, and one of the advantages when it comes to rebalancing is that there are no implications next tax season when assets are bought and sold this year via those accounts, said Rob Seltzer, an accountant and financial adviser at Seltzer Business Management. (Income taxes kick in at withdrawal, except for Roth IRAs.)

It’s a different story for taxable accounts, like a brokerage account. Here’s where the rules on capital gains — and capital losses — are going to turn any rebalancing now into something to factor for next year’s taxes.

Capital gains are taxed at 0%, 15% and 20%, depending on household income. That tax rate applies when the asset is sold, or “realized,” at least a year after the acquisition. When it’s less than a year, the proceeds are deemed ordinary income and taxed at whatever bracket the person falls into.

Investors can use their capital losses to offset the tax bill on their capital gains in a strategy known as tax loss harvesting. If capital losses exceed gains, the IRS will let you deduct another $3,000. Remaining losses can be carried over to future tax years, applied against future gains.

‘The individual should not let tax implications get in the way of their strategy. ‘

— Harris Holzberg of Holzberg Wealth Management

Suppose a person has $30,000 in capital gains, but $50,000 in capital losses, Seltzer said. The net loss is $20,000 and after the $3,000 deduction, the remaining $17,000 is carried forward to future years.

For this kind of tax planning and portfolio moves, it’s important to remember the IRS wash sale rules, Seltzer said. The tax authority will prevent an investor from taking a loss on a stock if they buy the same stock or a “substantially identical” stock either 30 days before or after the sale.

Taxes are important to remember, but keep perspective, said Harris Holzberg of Holzberg Wealth Management in California. “The individual should not let tax implications get in the way of their strategy. If they want to sell positions to preserve gains, then they should not let the tax tail wag the dog,” he said.   

Read also: Investors haven’t begun to price in recession — Here’s how far the S&P 500 could fall