December 12 2018 Market Update
Why are we Rebalancing?
Around year-end we tend to have a lot of conversations with clients about rebalancing, tax loss selling, and the role these strategies play in managing an investment portfolio. This conversation is all the more pertinent when volatility starts to spook investors – something we’ve seen in the past two months.
November offered a strong reminder of why we diversify: a significant selloff erased a year’s worth of gains on November 20th on growing fears around the technology stocks, regulation, trade, and economic prospects going into 2019. Just as quickly, accommodating language by Federal Reserve Chairman Jerome Powell later in the month soothed markets, and in the last week of November the S&P 500 Index gained 4.8% and the DOW Jones Industrial Average increased 5.2%.
Uncertainty is also heating up in bond markets. Yields on 5-year Treasury notes recently dropped below those for 3-year Treasuries for the first time in over a decade. This is largely considered an early warning sign for the economy, as “inversion” of the yield curve has occurred prior to each of the last seven recessions.*
But it’s important to remember that the rebalancing trades we recommend are not driven by short term market news. In other words, the rebalancing process is not simply a response to the market environment. It’s a realignment of your portfolio with your long-term investing strategy.
Here’s a look inside the rebalancing and tax loss harvesting process, and what it might mean for you.
The Basics of Rebalancing
You have undoubtedly heard us say – probably countless times if you’re a longtime client – that discipline is a critical part of your investment strategy. At JSF Financial, we don’t chase returns; we pursue results.
Results come from taking a methodical approach to investment management: carefully building a diversified portfolio that is designed to capture returns from different asset classes and shield you from their risks.
By diversifying and allocating investments based on empirically validated long-term performance (rather than short-term returns), we can focus on making the most of your strategy, and you can avoid the pitfalls of getting distracted by short-term volatility – namely the temptation to try to time markets.
Maintaining discipline means committing to rebalancing. As you accumulate returns in some asset classes and losses in others, the balance of your asset allocation will shift. For example, a portfolio with a 55% equity allocation might reach 65% in equities in a strong year – or drop to 45% in a weak one.
When we rebalance, we buy and sell in a way that brings your portfolio back into alignment with the investment strategy we built together. This serves two purposes:
First, it positions us for the future. Rebalancing provides an opportunity to harvest gains in high-performing asset classes, which takes money off the table and reduces your exposure to a potential downturn in that asset class. In simplistic terms, it can help us “sell high.” Rebalancing also provides a mechanism to put money to work in lower-performing asset classes. In layman’s terms, that means it can prompt us to “buy low.”
Second, rebalancing helps focus on the appropriate time horizon. We know what long-term results we want to see from the portfolio, and we’ve analyzed the portfolios to generate an asset allocation that we believe can deliver those results. By rebalancing, we’re staying in line with the big picture strategy.
There’s another useful reason to rebalance: managing your year-end tax bill. No investment strategy operates in a vacuum: every investor faces costs, and taxes can be among the largest – especially for high-net worth investors in non-pension accounts.
Our rebalancing strategy for your portfolio takes this into account. For many clients, we work directly with an accountant to determine how our investment management activities can support overall tax efficiency. When rebalancing, we make tactical decisions about which funds to buy and sell based on the potential for tax savings.
It’s important to keep in mind that each client is different: we tailor your rebalancing recommendations to your specific tax situation, your investment strategy, and your overall financial needs and goals.
Rebalancing in Volatile Markets
Of course, if you’re like many investors, the prospect of rebalancing just as markets are falling or volatile can be intimidating.
But this is part of the discipline of investing: we avoid timing markets and chasing short-term performance because we know that it simply does not work for the long run. The math shows that this approach isn’t worth the risk or the costs.
By methodically implementing your investment strategy, we’re looking to balance your exposures to the good, the bad, and the ugly in any particular asset class. This is an approach that has stood the test of time, and it’s our view that it’s the best way to pursue your investment goals.
Don’t Hesitate to Reach Out
You’ve likely already heard from us or will speak to us soon about year-end strategies for your portfolio. But please always feel free to reach out with your questions and concerns. We’re here to walk you through the process and guide you at every step of the way.
On behalf of all of us at JSF Financial, our thoughts and prayers are with those of you who have been affected by the California wildfires, and we offer our thanks to the firefighters and first responders who put their lives on the line to keep us safe.
Finally, as the year comes to a close, we’d like to express our sincerest appreciation for the trust you have placed in us. We appreciate working with you and hope that the holidays and the coming year will bring happiness and joy to you and your family. We look forward to seeing you in 2019!
*What does yield curve “inversion” mean? Yields, or the rate of return the holder of a Treasury note or bill will earn in interest, are typically higher for longer-dated bonds. “Inversion” just means that shorter-term yields are higher than longer-term ones.
Securities are offered through Mid Atlantic Capital Corporation (“MACC”) a registered broker dealer, Member FINRA/SIPC.
Investment advice is offered through JSF Financial, LLC, which is not a subsidiary or control affiliate of MACC.
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Historical data shown represents past performance and does not guarantee comparable future results. The information and statistical data contained herein were obtained from sources believed to be reliable but in no way are guaranteed by JSF Financial, LLC or MACC as to accuracy or completeness. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy. Diversification does not ensure a profit or guarantee against loss. Carefully consider the investment objectives, risks, charges and expenses of the trades referenced in this material before investing.
Asset Allocation and Diversification do not guarantee a profit or protect against a loss.
Inverted Yield Curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality.
The S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market.
VIX- The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market’s expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange.
3-, 5-, and 10-year treasury notes are a debt obligation issued by the United States government that mature in 3-, 5-, or 10 years, respectively. Treasury notes pay interest at a fixed rate once every six months and pay the face value to the holder at maturity.
The Bloomberg Barclays U.S. Aggregate Bond Index measures the performance of the total U.S. investment-grade bond market. The index includes investment-grade U.S. Treasury bonds, government-related bonds, corporate bonds, mortgage-backed pass-through securities, commercial mortgage-backed securities and asset-backed securities that are publicly offered for sale in the United States.
The MSCI Emerging Markets Index consists of 24 countries representing 10% of world market capitalization. The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 24 countries.
The MSCI Europe Index is part of the Modern Index Strategy and represents the performance of large and mid-cap equities across 15 developed countries in Europe. The Index has a number of sub-Indexes which cover various sub-regions market segments/sizes, sectors and covers approximately 85% of the free float-adjusted market capitalization in each country.
The MSCI World Index which is part of The Modern Index Strategy, is a broad global equity index that represents large and mid-cap equity performance across 23 developed markets countries. It covers approximately 85% of the free float-adjusted market capitalization in each country and MSCI World Index does not offer exposure to emerging markets.
 https://www.bloomberg.com/opinion/articles/2018-12-03/u-s-yield-curve-just-inverted-that-s-huge and https://www.bloomberg.com/news/articles/2018-12-04/as-yield-curve-inverts-there-s-a-bearish-omen-for-the-dollar?srnd=premium
Performance chart sources: