Movers and SHAKERS
IRA Thoughts: When Market Selloffs and Tax Season Collide
It seemed too good to be true. For the past 13 months, day after day, the overall stock market continued to break new highs. Despite earthquakes in California, the longest federal government shutdown in history, a Special Prosecutor investigating the U.S. President, global economic malaise, trade wars, inverted yield curve fears, the manufacturing contraction, the vote to impeach, lower earnings guidance, and the military flare-up with Iran, the market shook it all off and set record-high after record-high.
Less than two weeks ago, all three major indices again recorded new highs. However, the intense double-digit market selloff that followed, substantially reduces the odds of a new all-time high in the coming months. The impetus for this continuing selloff is not part of normal economic/market rhythm. Instead, it is the reasonable expectation that there will be a global slowdown from reduced economic activities related to coronavirus. In highly populated areas of China, the world’s second-largest economy, activity (both production and consumption) are reported to have come to a crawl. Other countries have taken drastic measures as well. Japan has gone as far as keeping kids home from school.
Investors Versus Traders
For long-term investors, the Nasdaq is up 28.21%%, the Dow has earned 8.80%, and the S&P is up 16.65% since January 1, 2019. This hardly seems worth worrying about. For shorter-term investors or traders, their entry may not leave them with the positive returns achieved over the past 13 ½ months. If they got in at the beginning of this year, they were confronted with forces that pushed the Nasdaq down 5.81%, the Dow down 12.04%, and S&P down 9.93%. The market declines are even higher for those entering since last Friday. Last week (a/o 2:30pm Friday), the declines are 12.56% for the Dow 30, 11.62% for the Nasdaq, and 12.07% for the S&P 500.
For those investing for future retirement, (not traders) with a longer-term horizon than those that have been looking for short-term gains, congratulations, stocks are still only 12.08% off their all-time highs. That isn’t all that bad if you participated in the run-up.
Current IRA Position
The above-average return of stocks, even after the sell-off, does not answer the question, “what do I do now?” More importantly, it doesn’t answer what to do with a new (2019 tax-year) contribution to your Roth or traditional IRA.
For existing assets, the wisdom of periodic rebalancing to bring the percent in various market classes back to the original plan’s allocation is based on sound reasoning. If a plan allocation calls for 50% equity, 40% fixed income, 5% real estate, and 5% cash with a quarterly rebalancing, the recent market moves should not change the plan. In practice, it is times such as the current “black swan event” that is the reason the risk/reward allocation with a periodic rebalance is being used.
In the past week, the fixed income portion of your portfolio has rallied dramatically. The entire yield curve is below the announced Federal Reserve’s targets. Benchmark bonds, such as the 10-year Treasury note are at their all-time most expensive levels. With this, it’s likely your allocation has exceeded 40% in this class. Your 50% equity allocation is likely lower than targetted in conjunction with your equity holdings. Real estate, particularly hotel REITs took less of a hit than most stocks, but are down as well.
A scheduled portfolio rebalancing would have assets moved automatically to this real estate position. With lowered interest rates, REITs should do better once the “dump everything” madness settles down. So a reallocation back to real estate investments would seem prudent. Dividend-paying REITs should gain investor attention as other market interest rates are miniscule. Lower interest rates also tend to add demand to the heavily financed real estate sector. So, low rates could add capital gains growth to real estate holdings going forward. Reallocating assets into the equity portion of the portfolio may be uncomfortable after such a harsh market turn. Keeping in mind the history of black swan events that have caused crashes, and the remember that the equity markets have since those events broken new highs, is a good reminder that we have always recovered in the past. In fact, after September 11, 2001, the markets recovered fully in less than 30 days after they reopened. The wisdom of rebalancing to the original strategy also forces you to sell and take profits in sectors that may not have much further to run. With interest rates at all-time lows (prices high), they may not have much more room to move in your favor. Selling expensive bonds and buying stocks that are relatively cheap is part of the rebalancing and makes sense.
The reason most advisors schedule rebalancing to the original allocation strategy is to take emotion and timing out of the decision to add to the sector that has been weakest and therefore could be cheap. If you have been managing your portfolio with scheduled rebalancing, nothing has changed to suggest you should deviate.
IRA assets are invested assets, not a trading account. The time horizon in almost all cases is longer than a year, and in most cases, much longer. Assuming there was an original strategic plan, there should not be any reason to deviate greatly from the plan. But, this may be a time to rethink how you are allocated within each class (Stocks, Bonds, RE). Not all securities within a class will react the same.
Within the Real Estate class, the sectors in which you place new money should be reviewed. Lodging and resort REITs have been particularly hard hit, whereas healthcare has outperformed. Self-storage has protected investors during economic downturns, infrastructure REITs are favorable during boom periods as are Timberland REITs. Diversifying within an asset class helps smooth out performance in any economic climate.
Moderation of large swings within fixed income is best attained by spreading the risk through both maturities and credit-quality. In all cases, the idea of a bond fund while rates are at their historic lows has a very low probability of success. Bond funds are valued based on the prices of the bonds within the portfolio. When interest rates rise off their lows, the prices of the bonds will go down. As the price goes down, so does the value of your bond fund. The same is true for individual bonds, but holders of the security, not the fund, can wait until the security matures (bond funds don’t mature, bonds do). When a holding matures, the owner will receive what they contracted to receive at purchase. This “known” return is what makes bonds appealing as an investment and bonds more attractive than bond funds when rates are below average.
Within the asset class of fixed income, investors for retirement may wish to invest relatively short-term (4 years or less). The difference between one-year Treasury rates at 1.18% and 10-year rates at 1.30% is small. So the idea of stretching your maturities longer would seem unfulfilling. As an alternative, lower quality corporate bonds offer higher rates. Investing in investment-grade notes (BBB- or higher) will add additional yield.
For the stock market portion of your “new money,” you could consider diversifying based on the current state of the market and expectations once this health crisis passes. What sectors within the class have been beaten down the most and expected to rebound (energy, travel, tourism, etc.)? What sectors did best during the crisis (health, biotech, consumer goods)? How will you diversify to reap the benefits of the next market jolt? Would you benefit from owning stocks where you can sell the most at risk and hold the best next time an unforeseen event happens? Individual stock purchases through most brokers are now typically less expensive than mutual funds. There is plenty of informed research to determine the fit of specific names. This research and analysis is available through both brokerage houses and companies like Morningstar and service like Channelchek.
One lesson investors have learned through this recent route is that diversifying through multiple index funds may be a false sense of security. Your exposure to a few hard hit companies may be greater than realized. If a company like Apple or Microsoft make up a high percentage of each of the indices in which you've invested you could have deeper losses than you may otherwise have had if you had not been as exposed.
Where the virus is going, we don’t know. The past is no guarantee of future returns, but we have survived through worse and then seen the markets set new highs sooner than we ever thought possible. I’ve heard a lot of “buy the dip” talk. If everyone was buying the dip, there would be no dip. So listen with skepticism and with an eye toward who is suggesting this. Are they politically motivated, profit-motivated, or a trusted source with your best interests in mind? If you’re uncomfortable with fully investing your new IRA contribution all at once in a market that may continue downward, you may want to place these new savings into a money market fund and have a sixth moved into the market at even increments on the same day each month. i.e., a $6,000 IRA contribution, then move $1,000 into a balanced fund every second Monday for six months.
Retirement money is a long-term investment. Bumps in the road are uncomfortable, but if you’re years from needing the assets, invest in a way that will most likely net you the most while tempering the rough ride.