During uncertain times like we are currently experiencing, what options do I have in respect to portfolio changes?

The first four months of 2022 have so far taken investors along for quite the ride. Thanks to record-high inflation in the US, rising interest rates, and geopolitical conflicts, many investors may feel uncertain about where they stand with their portfolio and may ask: What are my options? Below we lay out four common responses to this question. 

• Option #1: Move to Cash – For investors who are unable to stomach the uncertainty around market volatility, one option would be to move to cash. However, by moving to cash you may be decreasing your expected return moving forward. Additionally, reacting emotionally and moving to the sidelines could be detrimental to portfolio performance as you may miss out on some of the best performing days. See Exhibit #1 below for an example of the cost of missing the best performing days of the S&P 500.
• Option #2: Rebalance – Clients work with their financial advisors to develop a well-thought-out investment plan that will help them achieve their goals. One piece of putting together an investment plan may be setting a target asset allocation. Often, we see advisors working with clients to rebalance during periods of market volatility to ensure their risk and return preferences are being met and their target asset allocation is in line. During periods of relative equity underperformance, clients may choose to sell fixed income and buy into equities to keep their portfolio in line with their target asset allocation. 
• Option #3: Tax Loss Harvest – During market downturns, clients may work with their financial advisor to manage tax liabilities through loss harvesting opportunities. Certain clients may choose to sell to realize capital losses, which they may use to offset current or expected future capital gains. An effective method of tax loss harvesting, where a client goes directly from one fund to another and the transaction does not settle in cash, is an exchange transaction. Exchange transactions involve a sale out of one portfolio and a simultaneous purchase into another portfolio (must be within fund family, so Dimensional fund to Dimensional fund) that generally only incurs one ticket charge. Exchange transactions are treated as a redemption and purchase and in most circumstances are executed on the same day which can help minimize the amount of time you are not invested in the market. 
• Option #4: Stay Invested – To potentially enjoy the benefits of higher expected returns, investors should be willing to accept increased uncertainty. A key part of a good long-term investment experience is being able to stay with your investment philosophy, even during tough times. A well thought out, transparent investment approach can help people be better prepared to face uncertainty and may improve their ability to stick with their plan, tune out the noise, and potentially capture the long-term returns the capital markets have historically provided. See Exhibit #2 for an illustration of this.

We offer a variety of client-ready resources to communicate the benefits of long-term, patient investing. 

•  The Cost of Trying to Time the Market¹ – The impact of missing just a few of the market’s best days can be profound. Staying invested and focused on the long term helps ensure that you’re in a position to capture what the market has to offer. 
• The Capital Markets Have Rewarded Long-Term Investors² – The markets represent capitalism at work in the economy—and historically, free markets have provided a long-term return that has more than offset inflation. The data illustrates the beneficial role of stocks in creating real wealth over time. A key point is that not all stocks or bonds are the same. For example, consider the performance of US small cap stocks vs. large cap stocks over this time period and the cumulative difference in $1 invested in each index in 1926. Keep in mind that there’s risk and uncertainty in the markets. Historical results may not be repeated in the future. Nevertheless, the market is constantly pricing securities to reflect a positive expected return going forward. Otherwise, people would not invest their capital. 

Exhibit #1:

Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. 

Exhibit #2:

Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. 

This information is intended expressly for discussion purposes only and should not be misconstrued or otherwise interpreted as legal or tax advice. Please consult with qualified legal or tax professionals regarding your individual circumstances.

Sources: 

Dimensional Fund Advisors

¹ In USD. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 Index at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. 

² In US dollars. US Small Cap is the CRSP 6–10 Index. US Large Cap is the S&P 500 Index. US Long-Term Government Bonds is the IA SBBI US LT Govt TR USD. US Treasury Bills is the IA SBBI US 30 Day TBill TR USD. US Inflation is measured as changes in the US Consumer Price Index. CRSP data is provided by the Center for Research in Security Prices, University of Chicago. S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. US Long-term government bonds and Treasury bills data provided by Ibbotson Associates via Morningstar Direct. US Consumer Price Index data is provided by the US Department of Labor Bureau of Labor Statistics.