In recent weeks we’ve been covering some of the stuff you can and should be doing with your investments as we approach year-end. Today let’s add a final layer – the overall portfolio review.

Now, I’m of the opinion that you should be doing this frequently as a back-of-the-envelope check on things, especially during down markets. But if you’re only doing this once it might as well be at the end of the year.

Here’s the rough framework I use when reviewing a client’s portfolio.

• Have your needs changed?
  1. We’ve seen lots of volatility in all asset classes this year, even typical safe havens. This makes it tough to be a long-term investor. That’s obvious but it’s helpful to acknowledge the difference between how you feel about short-term performance and your actual financial situation.
  2. Have your financial needs changed recently? Have you retired from, lost, or gained a job? Have you received an inheritance? Has your health taken an unexpected turn?
  3. A “Yes” answer to any (and more) of these types of questions indicates the potential need to change your investment mix. At minimum it’s a good reason to talk with your humble financial planner to see what, if anything, you should be doing differently.
• How does #1 impact your investment decisions, if at all?
  • Maybe you’ll need cash soon for large expenses or just to get by.
  • Or maybe a new job or inheritance could let you save more.
  • Often, your needs haven’t really changed so there’s no meaningful impact to your investments. If so, you’ll want to be careful about making changes for the sake of making changes. I tend to look a lot more than I do.
• Then consider your investment allocation and portfolio structure. Is it still appropriate?
  • Assuming numbers 1-2 indicate no impact, and assuming you’ve been managing your portfolio for awhile and know the how’s and why’s of each investment, you can move on to basic rebalancing.
  • But let’s say 1-2 indicate a need for regular draws from your portfolio. Stock funds pay dividends quarterly and bond funds pay monthly. It can be helpful to turn off automatic reinvestment settings for your account to allow cash to accumulate. Then link your account to your bank and take money out on a schedule or as-needed.
  • Or maybe you need less money from your investments, or perhaps none at all. If so, ensure automatic reinvestments are turned on, especially in long-term accounts like Roth IRAs. This helps keep your money working while you’re not paying attention.
  • If you sense a mismatch between your allocation and your financial situation, look to make changes within your retirement accounts first. The reason is that you won’t have to worry about taxes when moving money between investments.
  • If you need to ratchet down your portfolio risk, a straightforward approach is to shift money from various stock funds into an index fund that tracks the S&P 500, or perhaps a variation that emphasizes dividend payers within the S&P 500. On the bond side, reduce the “duration” of the bonds in your portfolio while increasing credit quality. Duration is quoted in years and lower earns less over time but can be less volatile. This makes higher-quality lower duration bonds a good option for ringfencing spending money over perhaps a couple of years.
  • If ratcheting risk up instead, you can use the same S&P 500 index funds but just buy more. There are other asset classes such as emerging markets, preferred stocks, and junk bonds to juice up return potential, and all are at a discount right now. But each adds volatility too, so caveat emptor.
• What has and hasn’t worked this year and what’s the outlook?
  • The worst performing indexes so far this year include the NASDAQ, down about 29% and micro-cap stocks down about 22%. Large-cap indexes like the S&P 500 are down around 16%. Core bonds are down 12+%. What’s tough is that none of these areas are bad, they’re just down right now. In fact, stretch performance out over a 5yr period (or longer) and the order of performance gets reversed, with the NASDAQ up 89% over that timeframe including this year! Time in the markets works while timing them does not.
  • Your “dividend” funds are likely doing better, as are specific sectors such as Energy, Utilities, Consumer Staples, and Healthcare. Short-term and municipal bonds are doing better on their side of the fence too.
  • Because of this mixed performance there should be some decent rebalancing opportunities like we discussed a couple of weeks back.
  • For the outlook, inflation is slowly cooling down and the Fed is expected to raise rates just5% this week. A recession of some severity is still expected, but expectations aren’t as dire as a few months ago. That said, markets will continue be volatile until all this gets sorted out, likely well into next year.
  • You’ll want to stay invested and diversified because markets can and do rise amid all this uncertainty.
• Look at your investments for anything that stands out based on numbers 1-4 above. A common mismatch is long-dated and/or lower credit quality bonds holding short-term spending money. Or crypto variations used as a cash equivalent. Another is an unintentional overemphasis on a volatile asset class. Beyond that, if anything seems too confusing, duplicative, or expensive, now is a great time to fix the problem.

Managing investments is primarily an exercise in controlling what can be controlled. We double down on this in bad markets. Each investment in your portfolio should be there for a reason and the mix should make sense. If so, and your costs are low you can at least check the box for being diligent, whatever the markets may throw at you.

And you don’t have to worry about these details if we’re managing your portfolio – we’ve got you covered. As always, let us know of important changes in your life and ask questions.

Have questions? Ask me. I can help.

It seems like I wonder this every year about now, but how is it almost December? Like it or not we’re almost done with 2022 and there are boxes to check when it comes to our investments. I’m going to quickly offer some notes on two of them, rebalancing and RMDs, with more topics to follow next week.

It’s obviously been a rough year for the markets, as you can see from the chart below. Through the holiday-shortened trading day last Friday the stock market as measured by the S&P 500 index (not in the chart) is down about 15%. The Vanguard High Dividend Yield ETF (ticker symbol VYM) and the Vanguard Europe ETF (VGK) are mixed, from up almost 3% to down 16% year-to-date, respectively. You can see below how this performance is better than mere weeks ago, but it still hurts. Bonds are also down year-to-date, and that hurts more in a way, with the Vanguard Total Bond Market ETF (BND) and the Metropolitan West Total Return Fund (MWTIX) down 13% and 15%, respectively.

After 11 months of gyrations you probably need to rebalance your portfolio a bit. And maybe you have an RMD to take because you’re at least age 72 or perhaps have inherited a retirement account. Or maybe you just need to generate some cash for upcoming spending needs. Either way, let’s proceed…

A lot of people wait until year-end to process their RMD. This can be preferable in some cases, but RMDs have to be taken by 12/31 to avoid a penalty. The big brokerage firms are notoriously good at gumming up paperwork for last minute transactions, so the best time to take your RMD is now.

But what should you sell to generate cash in your IRA, 401(k), SEP account, etc? The rebalancing process can help with this question.

I charted the four funds above because they are some of the investments I actually use in client accounts. Each is high quality and I’m not necessarily concerned about this year’s performance – we still want to keep them. But what I’m focused on is rebalancing clients back to their target levels after the recent runup in prices.

The chart below shows holdings in a real account and their size relative to the target weighting I set. You’ll see that VYM has a target weighting of 12% but a current weighting of almost 14%, about 15% above target. VGK is up about 14% relative to its target. Conversely, the bond fund MWTIX is down 12% relative to target while BND is pretty flat.

Ordinarily I’d let VYM and VGK float a bit longer, perhaps up to a 20% variance, before doing anything. However, this client has an upcoming RMD and there’s room to cut, so we’ll trim back stocks and send money to the client’s bank account. I’ll then add remaining sale proceeds to bonds, most likely MWTIX since it’s lowest relative to target. Of course we could sell MWTIX instead of stocks because it’s already down and there must be something wrong with it. But that would create more of an imbalance in the client’s portfolio and, as I already indicated, there’s nothing wrong with the fund – it’s just down with the market.

Rebalancing like this helps ensure the components of our portfolios are allowed to move with market conditions, but not get too out of whack along the way. I do this throughout the year for clients but if you’re only doing this once, year-end seems like a good time.

Ideally you’d follow a process where each investment in your portfolio has a target to compare to. This requires data and tech to evaluate the data, something often challenging for a retail investor. Instead, you could look at a chart similar to the one I’ve posted above and generate cash from the best performers, not the worst. This year that’s probably dividend-oriented funds such as VYM or shorter-term bond funds that are down less than typical. Or maybe it’s from funds like VGK that have runup faster lately. Do the best with what data you have and remember to ask questions.

Also, the IRS doesn’t necessarily care what you do with your RMD – just that it leaves your retirement account and becomes taxable. This means you can punt any rebalancing decisions by moving shares of one or more investments from your retirement account into a non-retirement account. This might seem like a simple solution, but I definitely wouldn’t surprise your brokerage firm with this request too late in the year.

Another also: Remember that beginning at age 70.5 (the actual month and not earlier) you can gift directly to charity from your retirement account. This age limit is a holdover from when RMDs began at 70.5 instead of the current starting age of 72. Either way, you can direct your brokerage firm (or your humble financial planner) to have checks sent directly to charities from your account, up to $100,000 per year with no minimum. You won’t get to deduct the charitable contribution, but you won’t have to declare the distribution as income either. If you’re planning to make charitable gifts anyway and are required to take an RMD, Qualified Charitable Distributions are often the better option taxwise.

Have questions? Ask me. I can help.

What a crazy year it’s been for the markets! There’s been tons of volatility and the direction most of the time has been southward. Good days have often turned sour, and weeks will go by where it feels like you couldn’t buy a positive day. So it was wild to see just about everything going up dramatically following better-than-expected inflation data coming in last week.

Inflation has been on everyone’s mind this year and, for investors, it’s been all about how the Fed is responding by raising interest rates. With last week’s news of slowing inflation in October following slowing in September from highs in June, the lightning-fast thinking for investors was that the Fed could slow the pace and severity of its rate increases, reducing the risk of creating a recession or making it worse if we’re already dipping our toes into one. More positive data along these lines came in this morning and markets are continuing to respond favorably, at least so far.

Everyone wins if inflation continues to slow, but much remains to be seen in the months ahead. Perhaps ironically, these inflation numbers often get revised so if we end up having seen a major market reaction based on inaccurate numbers it wouldn’t be the first time, positive or negative. But I think in this case it’s less about the specific numbers and more about the changing inflation trend.

Anyway, I just wanted to share what the market reaction looked like last week. The chart below shows four indexes: the S&P 500 in green, developed foreign stocks in blue, the NASDAQ in orange, and bonds in light blue. It’s easy to see when the news came out! Yes, even after last week stocks are still down 15+% this year and bonds are just a hair better, but it’s still great to see such a positive response to generally positive news.

Among other things, one takeaway from last week’s performance is that it’s impossible to time entry and exists into and out of investments with precision over time. Maybe you get lucky once or even twice. But extend that into investing your serious money and you’re bound to get into trouble.

I’ve picked on the brokerage firm Robinhood in the past and reading what I’m posting below brought them to mind again. The average age of Robinhood clients is 32 and roughly half of its client base are first-timers. Robinhood was/is a proponent of the so-called democratization of finance and, while laudable, is tough to implement. A lot of new investors got sucked in via gamification and faux-free access to markets and rode markets higher before getting beat up this year. According to research by Schwab, many of these younger investors feel a bit chastened and are refocusing for the long-term. If so, this is great because getting the basics right and branching out from there is essential – there are no shortcuts and day trading is perilous at best.

Along these lines, here’s a note from JPMorgan that’s geared toward younger investors but is good information for anyone.

2022 has been a year of remarkable volatility across asset classes. Stocks, bonds and cryptocurrencies have been rocked by a confluence of challenges that could be described as a “perfect storm.” This volatility stems from a number of factors: COVID-19 and its impact on growth in Asia; the war in Ukraine and its impact on global commodity prices; severe economic slowdown thanks in part to a massive fiscal drag; midterm elections, which lead to uncertainty surrounding future policy; multi-decade high inflation; and steadily rising interest rates as global central banks shift policy from accommodative to restrictive. 

Asset price volatility impacts all investors regardless of age or income levels. Still, younger investors - namely Millennials and Gen Zers - may struggle more than most. Some of this can be attributed to their relative inexperience in markets, as many had not invested through a bear market; some can be attributed to the lack of guardrails in modern investing, with online brokerage platforms allowing for low- or no-cost access to markets without corresponding advice; and some can be attributed to the composition of younger investors’ portfolios, which heavily favor single securities (like stocks and cryptocurrencies) and options. 

Given these circumstances, many younger investors may be wondering how to make sense of current conditions. Broadly speaking, there are three simple steps to better weather volatility:

• Diversify portfolios away from heavily concentrated positions in risky assets. The benefits of the “democratization” of investing in recent years are myriad and it would be imprudent to recommend that young investors liquidate volatile but long-term assets like cryptocurrency. However, it is worth building a well-diversified portfolio around these riskier holdings to mitigate volatility while still embracing risk, which is necessary for young investors given their long-term time horizon, relatively low liquidity needs and poor short-term market prospects.
• Dollar-cost average into markets to avoid market timing pitfalls. Ideally, most young investors are already dollar-cost averaging through regular contributions to 401(k)s. Moreover, these 401(k)s can be “enhanced” by increasing contribution amounts or shifting, if appropriate, into a post-tax “Roth” vehicle. If an investor has reached their contribution limit, investments into non-qualified accounts can be made in the same manner.
• Recognize that heightened volatility is structural in modern markets. Markets, and information more broadly, move faster today than ever. Given the rise of algorithmic trading, high-frequency trading and a more empowered retail investor, this trend will likely accelerate. For this reason, young investors should recognize that future markets will continue to be volatile and become comfortable with this volatility.

All told, younger investors may find today’s volatile market environment uniquely challenging. However, it is possible to manage through these challenges and emerge on the other side with better financial health.

Asset ownership by age group

Here’s a link to JPMorgan’s website if you’d like to read the piece there.

https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/market-updates/on-the-minds-of-investors/how-can-millennials-ride-out-the-current-market-storm/?email_campaign=304062&email_job=353218&email_contact=003j0000018XcwiAAC&utm_source=clients&utm_medium=email&utm_campaign=ima-mi-publication-wmr-Earnings-11142022&memid=7220927&email_id=65707&decryptFlag=No&e=ZZ&t=613&f=&utm_content=Read-the-latest

Have questions? Ask me. I can help.

Last week we touched on typical year-end topics like taking Required Minimum Distributions and how portfolio rebalancing can help free up the necessary cash. Now let’s look at an unfortunate reality for this year-end: harvesting losses.

If you’re like most investors your portfolio is probably showing some losses right now. And if you were paying attention you likely saw losses ebb and flow starting in about March. Even if you harvested back then or perhaps multiple times already it likely makes sense to look again. Markets have continued to struggle and, even though prices have recovered a bit in recent weeks, losses remain.

Take a look at this simple chart of four broad market index funds to see how there were several major lows where you could have harvested as the year progressed.

There are different schools of thought on this, but I think harvesting losses is worthwhile for two primary reasons: one, if done correctly harvesting losses lowers your household’s tax bill and this helps to indirectly increase your investment performance; two, for the most part we don’t have to worry about transaction costs, so the only direct cost associated with harvesting losses is your time. By the way, I think this last point feeds into some of the criticism (if that’s the correct word) of harvesting losses. It’s time consuming and requires holding a lot of details, and that often makes it difficult for some people, including professional money managers, to want to bother with it.

Here’s a primer on how this works. As a reminder, tax loss harvesting only applies to your individual accounts, trust accounts, and so forth, not to your retirement accounts. Ask your tax advisor (or me) for more details.

First things first – Why do we want to do this?

Losses in our investment accounts are unrealized (often called paper losses) until we sell and realize them. Nobody wants to lose money and eventually losses on high quality investments will turn into gains. But is it possible to reap some benefits from the low points along the way? That’s what loss harvesting is all about.

Say you bought $10,000 worth of a S&P 500 index fund earlier this year that’s now worth $8,000, for a $2,000 unrealized loss. This is a core holding and the fund is high quality, it’s just down with the market. What should you do?

You could simply hold the investment as a long-term investor should. There’s nothing necessarily wrong with that. But what about that unrealized loss… shouldn’t we try to find a silver lining? I say yes!

You do this by selling the investment (you can sell a portion but let’s assume you sell the whole thing) and not rebuying it for at least 30 days. You also shouldn’t have bought any shares during the prior 30 days. This is tracked by your brokerage firm and creates a 60-day window around whatever date you’re thinking about selling shares. Once you’re out for that long you have realized a capital loss and can use it to offset capital gains from other sales or those pesky taxable year-end mutual fund gain distributions. And if you have losses left at year-end you can use up to $3,000 as a tax deduction. Remaining losses carry over until fully used. In other words, losses are valuable at tax time.

While you’re welcome to sit in cash for a month or so after selling the investment, you can and should buy something else while you wait. And this is actually the goal from a portfolio management standpoint – to not rock the boat too much in terms of your investment mix. The tricky part is the new investment is essentially a placeholder that can’t be overly similar to what you just sold, or you risk triggering what’s called a wash sale and invalidating your loss. And this applies to all of your family’s accounts. No selling in yours and buying back immediately in your spouse’s account or selling in your brokerage account and then immediately buying back in your Roth IRA.

The details get complicated, but a simple approach to finding a placeholder is to change management style or regions. For example, if you’re selling a passively managed ETF like the S&P 500 fund, SPY, you could use an actively managed mutual fund that owns large cap US stocks. Or you could use a foreign ETF in place of a domestic ETF. It’s not perfect but keeps you invested. That way if markets rise during the month or so while you’re out of SPY you’re still getting some benefit. And if you own SPY in multiple accounts, remember that you’re only selling shares in your non-retirement account, so you still have exposure to the S&P 500, just less for a while. Worse case, you’ll have some gain when you sell your placeholder that uses up some of your harvested loss. But that’s a great problem to have, right? Or maybe markets continue to fall, and you harvest more losses when moving back into your original investment.

The thinking is similar with bond funds in terms of swapping management style and bond categories. For example, you could sell a medium-term bond ETF that is passively managed and that holds a lot of US Treasurys and swap for a medium-term CA municipal bond fund as a placeholder. This keeps your bond allocation roughly in line until you go back to your original holding. Maybe you decide to keep your placeholder for a while – there’s no rule requiring a roundtrip.

Again, there’s a lot of detail here and I’ve just scratched the surface. The point is that if you haven’t harvested this year I highly suggest taking a look at your unrealized gain and loss information prior to year-end. Or if you harvested months ago, take another look. Maybe you decide to do nothing. At least you’re making an informed decision.

And you don’t have to worry about these details if we’re managing your portfolio – we’ve got you covered.

Have questions? Ask me. I can help.

Good morning. I’m taking a brief hiatus from writing my blog this week in anticipation of Thanksgiving. I don’t know about you, but I tend to value this holiday more as I get older. It’s a time for appreciating those around me and all that my family and I have to be thankful for. Of course we can and should be thankful and appreciative all year round, but I like the focus on it that the holiday brings. Oh, and the food – we can’t forget about the food.

Anyway, I wanted to share a few articles getting into the details of the latest rapid rise and shocking fall of a cryptocurrency star. This time it’s a firm called FTX, a crypto exchange that’s looking more like a Ponzi scheme of epic proportions as more information comes out.

This sort of situation is instructive because it reminds us that it’s almost always the people behind the tech who cause the problems, rarely the tech itself. Digital assets (the industry catch-all term for crypto) are the way of the future and some structures like bitcoin will eventually revolutionize aspects of our financial system. Not yet, but it’s fashionable and profitable to pretend so. Celebs and other bigwigs have jumped on the bandwagon and this, in a sense, helps to mainstream these technologies. But along the way hubris and old-fashioned greed create cautionary tales like this and, unfortunately, lost fortunes along the way.

So if you find yourself needing something to read as you digest your Thanksgiving feast check out these articles and feel thankful you weren’t (hopefully) an FTX investor.

From my family to yours, Happy Thanksgiving!

Here’s an article from Vox that provides a good overview of the situation.

https://www.vox.com/the-goods/23451761/ftx-sam-bankman-fried-bankrupt-binance-bitcoin-alameda

Here’s one from The Wall Street Journal offering additional detail. Let me know if you run into the paywall and I can send this to you from my account.

https://www.wsj.com/articles/how-ftx-sam-bankman-fried-went-from-crypto-golden-boy-to-villain-11668199208

And here’s a longer investigative-journalist-type of article that provides a lot of detail and interesting insights into what went wrong with FTX (and it's key subsidiary, Alameda Research), the personalities, and offers some explanations as to why this happened.

https://milkyeggs.com/?p=175

Beyond that just Google “FTX collapse” and jump down the rabbit hole.

Have questions? Ask me. I can help.

Inflation has been working it’s dark magic in a variety of ways for the last year or so. We’re all painfully aware of it’s impact on gasoline prices, food, housing, and just about everything else under the sun that costs money. It’s not all bad news, however. Most government limits on retirement savings are tied to inflation and have recently been increased for 2023, allowing us to save more for our future. Of course this only helps if we can afford it, but more opportunity is better than less, right?

Here’s a rundown of some of the updates to keep in mind for next year if you’re still saving for retirement.

Individuals younger than 50 can contribute $22,500, up from $20,500 this year, to their 401(k), 403(b), and 457 plans. The “catch-up” contribution for those 50 or older goes up to $7,500 from $6,500 for a potential total contribution of $30,000 from the employee in 2023 for those 50 or older. Company matching doesn’t impact these limits.

The maximum IRA contribution increases to $6,500 from $6,000. The catch-up works the same way as above but is still $1,000 like this year because, for whatever reason, that provision isn’t tied to inflation.

The phase-out ranges impacting deductibility of IRA contributions are tied to inflation, so those are rising too and allow savers to earn from $5,000 to $7,000 more of income and still deduct contributions on their taxes. For example, a single person could earn up to $83,000 next year and deduct some of their IRA contribution. Married couples can go up to $136,000 of income. (That’s a simplified way to look at the phase-outs, but a tax advisor can help determine if they impact you.) The phase-out ranges are even higher for Roth IRA contributions.

The personal and family limits for HSA contributions will go up to $3,850 and $7,750, respectively. HSAs also have a catch-up provision that starts at age 55 but, as with IRAs, is still $1,000.

Here’s a link to an IRS document for more minutia and inflation adjustments to other provisions.

https://www.irs.gov/pub/irs-drop/n-22-55.pdf

This extra room to save into tax deferred accounts comes at a good time given the tumult in stock and bond markets. Through last Friday, the S&P 500 is down 20% this year while Big Tech and other sectors are down 30+%. Medium-term bonds are down maybe 12% - 20%, depending on type. This means that long-term money can be saved today at a discount. These next several months tend to be some of the best of the year for the markets, so planning to front-load your accounts early in the new year (and topping off your accounts for this year as well) may make sense, again assuming you can afford it.

A risk here is getting too carried away with retirement savings and neglecting your emergency fund. Generally speaking, withdrawing from a retirement account before age 59 ½ comes with taxes and a penalty, so avoid overextending yourself. Always, always, always, keep a clear line between what of your savings is investible for the long-term and what needs to be kept at the bank for short-term liquidity.

A quick note on interest rates…

By now you’ve heard that the Fed raised it’s short-term benchmark interest rate by 0.75% again last week. As I’ve mentioned in other posts, each change reverberates throughout the US and global economies, and we’ve now had six increases since March. That’s a lot in a short time and more increases are expected. In fact, much of the market’s gyrations this year and again last week were based on rapidly (literally as Fed Chair Jerome Powell was giving his press conference on Wednesday) evolving thoughts on where the Fed’s collective head is at with rates – what’s their target? We began the year with short-term rates at essentially 0% and now we’re at 4%. A variety of folks are expecting we need to get to 5% or 6% before the Fed stops raising for a while to let things settle, but that outlook changes often. Inflation, at least according to the Fed, is expected to wane into next summer but Fed officials say they want to see that happen “decisively” before changing their stance on rates.

I mention all this again because the common thread from most market prognosticators is to expect that rates will remain high for some time, perhaps a couple of years or longer. This has likely already impacted your personal balance sheet by increasing the cost of any variable rate debt, say on a home equity line, while also potentially reducing your home’s value: a double whammy. If you still have variable debt tied to PRIME (now at 7%, up from 3.25% in January) or perhaps a LIBOR index (at 4.6%, up from maybe 0.2% in January, depending on which LIBOR term we’re looking at), call the lender to see about transitioning to a fixed rate. That may not be an option, or it may not make the best sense for you based on your loan terms, but I can help evaluate if there’s any way to refi out of rising-rate debt or perhaps pay it off with other assets.

Have questions? Ask me. I can help.