Your Investment Strategy in the Current Market Environment

The recent record highs in the stock market and concerns about the future of interest rates and the bond market have created some unique challenges for investors. The exuberance from the strong stock market has been tempered by concerns about the slow recovery that the economy is experiencing in the US and abroad. The policy responses of the Federal Reserve Bank here and by other governments around the world have probably provided a lot of the impetus for the strength of markets, but we all realize it cannot last forever. Add to that the impact of our historically low interest rates and the potential impact on bonds going forward, and investors are not feeling very euphoric over the recent highs.

In times like these, as in times when the markets are down significantly, we believe that communication is critical. You first need to understand whether you are excited about the current stock market returns or fearful of a potential downturn. For many individuals, the experience of 2008/2009 still looms large. While markets have recovered, and gone beyond prior levels, the scars still remain. Hopefully we have also learned something from that painful experience and can apply it to the current financial situation.

Getting back to basics and focused on your financial planning should always be the first step in the process. Knowing the status in reaching your goals is critical. If you have done the proper financial planning, you should know what the required rate of return is to achieve your goals. This, along with your risk tolerance is essential in determining an appropriate asset allocation to meet your goals. Time horizon is also an important factor as is your “stage of life”. If you are retired, and not accumulating funds any longer, it may be much harder emotionally (and financially) to tolerate the next downturn.

1. Review your asset allocation – It is very easy to get out of balance with the targets when we go through periods of strong performance in the equity markets like we have seen recently. If your portfolio is more equity oriented than your planning calls for, you’re probably taking more risk than you should be taking.
2. Reassess cash flow needs and make sure cash reserves are sufficient – If you are drawing down your portfolio, watching the sufficiency of your assets becomes critical to your financial and emotional well being. Good financial planning typically encourages one to have at least 2-3 years of cash flow available in cash or short term bond investments so that they are not drawing down on stock investments at the “wrong time” in the stock market cycle.
3. Broadly diversify your portfolios – We do not know what economic scenarios might develop over the short and long term. Do you have parts of your portfolio that will behave well if inflation comes back into the picture? What about if the stock market has a 10-20% correction? Diversification into alternative strategies, commodities, real estate, and other asset classes can help to balance out returns over the long term.
4. Examine your bond portfolios – With rates at such low levels, it is a very good time to make sure you understand your exposure to rising interest rates. The bond market was hit pretty hard in May as 10 year treasury yields rose almost .50%.   How did your bond portfolio hold up?  In many senses, rising rates will be good for investors as they will get higher yields on bonds, CDs , etc. Many of our clients have significant bond portfolios, what is the duration of those bonds? Have you done anything to shorten the maturities to reduce risk? Have you considered using other fixed income asset classes such as international bonds, emerging market debt, high yield bonds, or TIPS to further diversify bond exposure?

Integrating income tax planning into the investment strategy is more important now than it has been in many years. With the increased individual tax rates for higher income individuals that started in 2013, along with the Medicare Surtax and the fact that many states have raised income tax rates too, taxes are taking a MUCH larger bite out of your investment income than in past years. Do you know what the impact of the rate increases are and how it will affect you?

This may also be an ideal time to consider some tax motivated investment moves. With the stock market up so much, even with potentially higher capital gains tax rates, it might be time to trim that concentrated stock position. Roth conversions may still make sense and if you did conversions last year, seeing if recharacterization is needed is always a good step to take. Estate planning strategies in this ultra low interest rate environment can still go a long way in transferring wealth to the next generation. While we did not “lose” the higher estate tax exemptions at the end of 2012 as many feared, who knows what the future will bring. If you have not fully used your lifetime exemptions ($5.25 million this year), perhaps you should consider this now. This will entail getting help to understand the sufficiency of your asset base before you make such a move.

By focusing on keeping your  attention on your long term goals and the real returns from your portfolio,  you will make sure that you keep it  allocated in a way that makes sense.