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Embracing the Roller Coaster Ride: The Benefits of Market Volatility

The spring of 2020 brought a host of new stresses and concerns as the pandemic abruptly pushed normal life aside throughout our country.  For investors, those concerns included the significant drop in the stock market and wild market volatility during that time.  Fear about the economic impact of the pandemic led to daily swings of 5 to 10 percent in the stock market on multiple occasions in late March.  The Volatility Index (VIX) created by the Chicago Board Options Exchange, which measures price changes in the S&P 500 index, reached levels approaching—and, on March 16, 2020, even surpassing—the level of market volatility during the Great Recession.

While such levels of volatility are stressful to experience (and certainly a bit stressful to manage as investment advisers!), the stock market behaving like a roller coaster ride does present opportunities that can add significant value to investment portfolios.  Three ways to take advantage of market volatility are:  conducting trades to rebalance one’s portfolio, harvesting tax losses in a taxable account, and changing one’s monthly investments or withdrawals.

Rebalancing Trades.  If you have set targets for your portfolio and rebalance your accounts during periods of market volatility, you can increase the value of your investments while maintaining a tolerable amount of risk.  For example, consider an investor who had a $1 million portfolio in February 2020 and kept 70% of his portfolio in stocks and 30% in cash and bonds.  By late March, the value of his stock funds dropped by ~$250,000 while the value of his bond funds held steady.  As a result, the stock portion of his portfolio now represented only 60% of the total portfolio.  If he rebalanced to his target allocation (70% stocks / 30% cash and bonds) in late March, he would have used a portion of the cash and bonds to buy more stocks “on sale” while maintaining his desired level of risk.  In 2020, such a move would have paid off quickly, and by the spring of 2021, the investor’s portfolio would likely be worth over $1.15 million. 

Tax Loss Harvesting.  Another advantage of market volatility is that investors can harvest tax losses in a taxable account.  Consider an investor who purchased $100,000 in an S&P 500 Index fund in a taxable investment account in mid-February 2020.  By late March, the value of his investment had dropped to $70,000.  In that case, he could sell the current fund, buy a comparable S&P index fund as soon as possible thereafter, and realize a $30,000 capital loss for tax purposes while still benefiting from the rebound in the same segment of the stock market in which he initially invested.  For most investors, that $30,000 capital loss translates into $4,500 of federal tax savings, though it may have to be spread over a number of years given the annual limits on claiming capital losses.

There are several potential pitfalls in tax loss harvesting though.  For example, an investor should 1) ensure that she reinvests the proceeds of the sale in a similar investment while not triggering wash sale rules, 2) consider how tax loss harvesting trades could be offset by rebalancing trades in a retirement account instead (to further remove concerns of violating wash sale rules), 3) conduct the trades during the same business day if possible (or back-to-back days) to minimize the amount of price movement while her assets are out of the market (this is easier when realizing losses in stocks or ETFs that trade throughout the day, rather than mutual funds that only trade at market close), and 4) consider how best to use the tax asset resulting from the capital losses.

Changing Monthly Investments and Withdrawals.  Investors can also take advantage of market volatility by adjusting the allocation of their periodic investments—or withdrawals if they are taking regular distributions in retirement.  Imagine that an investor is still working and that she saves $2,000 per month to a taxable investment account.  Of that $2,000, she generally invests $1,500 in a stock fund and $500 in a bond fund.  When the market drops significantly, she can adjust her monthly investments so that all $2,000 is used for purchases of the stock fund while it is “on sale.” 

Conversely, a retired investor might sell $2,000 of investments per month to generate cash for his living expenses.  If he usually sells $1,500 of a stock fund and $500 of a bond fund each month but the stock market has just taken a nosedive, he could adjust his monthly sales to draw all $2,000 from the bond fund instead until the market recovers.

Each of these strategies demonstrate how—without trying to time or outguess the market—an investor can still be proactive in taking advantage of market volatility and thereby add value to their portfolio while maintaining an appropriate level of risk.  Above all though, it is most important in the face of market volatility to follow a steady course, not reacting emotionally to swings in the market but sticking to a target allocation for your portfolio that you hopefully set in place during a calmer time.  If any clients have questions about these strategies (or how we may have implemented them on your behalf), please call or email any time.

PFS advisers Rob Copeland and Renee Sewall presented the following webinar on May 25, 2021. They discussed how to conduct charitable giving tax-efficiently in light of your financial situation, charitable goals, and phase of life.

If any clients have questions about whether these strategies might be appropriate for you, please call or email us any time.

A few years ago, the Wall Street Journal published an article entitled, How Couples Can Resolve Their Biggest Fights Over Money.  The article points out, as most couples are aware, that money is one of the biggest sources of marital conflict.  According to the primary expert in the article, financial psychologist Dr. Brad Klontz, in many marriages, one spouse tends to be more of a saver and one tends to be a spender.  He explains that these predispositions are often rooted in fears and emotional baggage related to money that date back to childhood.  While uncovering and listening to these fears is obviously central to diffusing the conflict, Dr. Klontz also advocates the pragmatic approach of setting savings goals and seeking compromise on how to achieve them.

This is where a financial advisor can help.  The process of developing a financial plan encourages couples to discuss and outline their financial goals.  This includes determining the timing and amount needed for short-term goals, such as new cars, vacations, and home renovations, as well as long-term goals, such as retirement, college funding, a house purchase, etc.  The financial plan provides an opportunity for couples to discuss the alternatives and to establish and prioritize their goals together.  For example, one couple we know recently decided that their primary goal was to buy a boat in retirement because they love spending time together on the water, and they were willing to downsize their home and delay retirement by a year to reach that goal.

The experience of working with a financial adviser can also help bridge the gap in relationships in which one person is generally in charge of (and comfortable with) the family finances and the other is not.  Working on a financial plan and building a relationship with an adviser together can empower the less involved spouse and help him or her feel comfortable about the future if something happens to the more involved spouse. 

The financial plan process also provides direction on the necessary steps to reaching financial goals, which can help mitigate tension between the spending spouse and the saving spouse.  Once a couple has outlined their goals, we advise how much they need to save (and through what vehicles) in order to get there.  If a couple is meeting their savings targets, then the “saver” can feel free to enjoy spending any extra cash flow.  If the couple is not meeting their savings targets, then the “spender” can see that further restraint is required to meet their goals.  In either case, having an objective third party involved might lessen the tension, since both spouses can feel free to throw their financial advisor under the proverbial bus: “Honey, the plan says that it’s okay/not okay to spend this much in light of the goals that we set together!”

Furthermore, having an adviser manage investments and/or provide guidance on financial decisions can lessen stress when spouses are dealing with other difficult situations that might put a strain on their marriage, such as job loss, physical or mental health issues for themselves or their children, etc. Knowing that their financial life is on the right track allows them to focus their attention elsewhere and hopefully have more time and energy to face whatever challenges and crises may come along.

While single individuals may not experience the same type of tension with a spouse, the primary benefits of having an advisor develop (or update) a financial plan still apply.  It forces them to think through and prioritize their financial goals, and then they are able to enjoy spending any extra cash flow guilt-free when they know that they are saving enough to achieve their goals.  Additionally, working with an adviser may increase their comfort in managing their finances, since we’re happy to explain any financial recommendations in more detail and/or give an overview on any financial topic when clients are interested.  Advisers can also serve as a sounding board for financial decisions when there aren’t other household members to fill that role.

If you think that starting or updating a financial plan would be beneficial for you, please don’t hesitate to reach out.

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