Year-End Moves to Protect Your Investment Portfolio
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As 2018 draws to a close, investors may be feeling increasingly anxious.
The stock market has delivered sharp shocks this year, with the Standard & Poor’s 500 index of U.S. large-company stocks falling nearly 7 percent in October, erasing most of its gain for the year. The MSCI EAFE, an index of foreign stocks, dropped 8 percent. Even bonds slumped, with the Bloomberg Barclays U.S. Aggregate index down 0.7 percent for that month.
Stocks have retraced some of those losses. But the current bull market is going into its 10th year, the longest run in U.S. history, which means more volatility may lie ahead.
“This is what you should expect in the late innings of a bull market,” says Amanda Agati, co-chief investment strategist at PNC Financial Services Group.
Even so, most forecasters aren't expecting an immediate end to the stock market rally. The economy shows continued strength—gross domestic product rose 3.5 percent in the third quarter—and a recession is unlikely in 2019, Agati says.
Of course, no one can accurately predict the direction of the market. But given the recent downturn, now is a good time to review your portfolio to make sure you're on track toward your financial goals and you aren't taking on more risk than you realize. Here are four moves to make:
Do a Risk Review
The more you hold in stocks, the more likely you are to suffer large losses in a market downturn. So if you haven’t revisited your overall mix of stocks and bonds recently, you'd better take a look. Over the years, your ability to tolerate risk may have changed. Perhaps stock market dips are starting to make you lose sleep, or you’re getting closer to retirement.
“Reviewing your risk capacity means asking yourself how much volatility can your portfolio handle without it changing your plans,” says Christine Benz, director of personal finance at Morningstar. “For someone closer to retirement, a 40 percent loss in a bear market could make retiring harder.”
If that’s your situation, you may want to shift your asset mix to a more conservative allocation. That doesn't mean you should abandon stocks, which remain your best bet to stay ahead of inflation over the long term. Those who are younger—and can hold on during market downturns—may do well sticking with a large allocation to equities, Benz says.
But if you need to be more cautious, dial down your holdings in stocks and boost your fixed-income allocation. As a guideline, look at the stock and bond mix for a target-date retirement fund that dovetails with your investment horizon. For example, a Vanguard Retirement 2020 fund invests 54 percent of assets in stocks and 46 percent in bonds, while the 2030 fund keeps 70 percent in stocks with the rest in bonds.
Rebalance Your Mix
Even if you’re comfortable with your portfolio’s asset allocation, you may still need to make a few tweaks. That’s especially true if you haven’t rebalanced in a few years. A portfolio that was 60 percent invested in stocks and 40 percent in bonds at the start of the bull market would now be closer to having 80 percent invested in stocks.
To bring your portfolio back into balance, shift money from your winning investments into those that are lagging. That will probably require you to take profits in your highest-flying stock funds, which could be a timely move. “Stocks that lead on the way up often tend to lead on the way down,” says Jeffrey DeMaso, director of research at Adviser Investments.
Still, rebalancing isn't a strategy designed to shoot for higher returns. Rather, “it’s how you protect your portfolio from becoming overly risky as stocks rise,” says David A. Schneider, a certified financial planner in New York City.
Rebalancing is easy to do in a tax-sheltered account like a 401(k) or IRA, because selling won’t incur a tax bill. In taxable accounts, you can take a more gradual approach by directing future contributions to the lagging investments. Or you may be able to use taxable losses to lower your tax bill. For more on that, keep reading.
Tax Advantage of Tax Breaks
There’s a silver lining to the market’s recent turmoil: You may have shares of mutual funds or exchange-traded funds that you can sell at a loss. Federal law allows you to use taxable losses to offset taxable gains.
Under IRS rules, if you’ve held an investment for less than a year before selling it, any gains will be taxed as ordinary income. But gains on investments held for at least one year are subject to a long-term capital gains tax, which is typically lower than income tax rates.
If your taxable losses are greater than your taxable gains, you can deduct up to $3,000 of those losses on your federal tax return. Losses above that can be claimed in subsequent tax years. (When you sell an investment for a loss that you deduct, you must wait 30 days before repurchasing the same investment or one that's similar.)
For those who intend to make a charitable gift, consider donating appreciated investments, which can help lower the taxes due on your gains. To qualify for a deduction under the new tax law, however, you will need to itemize deductions rather than take the standard deduction. For retirees who have yet to take their required minimum distributions from an IRA this year, you could make a Qualified Charitable Distribution (QCD) directly from your IRA to a charity. “This isn’t a move just for the wealthy; it will save you on taxes no matter how much you contribute,” says Benz.
Earn More Income Safely
For low-risk investors, there’s some welcome news: You can finally earn a decent yield on safe assets. That’s because the Federal Reserve has continued to raise its key interest rate, which has pushed up yields on bank savings accounts and short-term fixed-income investments such as money market funds and certificates of deposit.
If you have a cash allocation in your portfolio that's sitting in a walk-in bank and earning only 0.09 percent, on average, consider doing some online shopping for higher-yielding cash investments. Plenty of online banks now pay more than 2 percent on savings accounts.
For those who don’t mind taking on a bit more risk, short-term bond funds also pay decent yields. For example, the Vanguard Short-Term Investment-Grade Bond Fund has a current yield of 2.6 percent, and during the October slump, it fell just 0.38 percent—nothing to lose sleep over.
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