Yesterday Britain voted to leave the European Union, sending shock waves through the market today. The US stock market declined approximately 3.6% and international markets were down approximately 7.7%. Many investors are left feeling uneasy and uncertain about how this impacts them and what they should do now. Here are three considerations:
1) For the long-term investor, this is just noise
Today’s volatility may have you thinking it’s time to get out of stocks or at least out of international stocks. In times like these, it’s important to remember your long-term plan. Your financial plan is the result of your life goals as well as your ability, willingness, and need to take risk. Changes to your plan, and therefore your portfolio, should be driven by changes in your life, not market volatility.
A well-constructed portfolio includes stocks for long-term growth. Even in the long run, there is a significant amount of uncertainty involved with stocks, which is why broad diversification across geographic regions is so important. If we knew for sure what the best-performing parts of the stock market would be over the coming decades, we would invest our entire stock allocation there, but alas we don’t. In fact, this uncertainty about the stock market contributes heavily to the expected premium stocks earn over less volatile investments like bonds. Unfortunately diversification across different segments of the stock market (e.g. owning domestic and international stocks) often doesn’t help much with systematic declines like we experienced today, but broad diversification still gives you the best probability of long-term success and thus is important to maintain.
To help mitigate short-term stock market declines and ensure you have the money you need for shorter-term goals, part of your portfolio should also be invested in bonds. Your ability, willingness, and need to take risk determines what the proportion of stock to bonds in your portfolio should be. Unlike stocks, where the primary objective is long-term growth, the purpose of bonds is it to be the ballast in your portfolio, which is why you should only invest in very high-quality bonds. The bond allocation of our clients’ portfolios is heavily composed of US government bonds, which are considered the lowest-risk investment available. As a result, the expected return on these type of bonds, albeit low, is very reliable and easy to estimate ahead of time. In addition, the value of these bonds often increases amidst global market concerns, which helps to offset some of the stock market declines and even provide “dry powder” to rebalance your portfolio. Having an appropriate allocation to high-quality bonds better allows investors to weather the storm and stay the course amidst stock market volatility.
With a well-constructed long-term portfolio and the right mindset, today’s events are simply noise that you should ignore. While it’s natural to feel compelled to take action, history has taught us time and time again that when it comes to investing the best thing you can do is follow your plan instead of your emotions.
2) For the tax-smart investor, this is an opportunity to reduce your tax bill
While long-term investors shouldn’t change their exposure to international stocks, they should review their portfolio for any positions that have an unrealized loss. With relatively low returns over the past several years and today’s precipitous market decline, many investors will find the international positions in their taxable accounts are currently at a loss. Capital losses on your investments can be used to offset capital gains and even a small portion of ordinary income. By selling positions that are at a loss you’re able to “harvest” this tax loss. You can then immediately reinvest the proceeds into a similar (but not substantially identical) investment so that you can maintain your desired asset allocation. This way you won’t miss out on future growth or a rebound, but you'll also get the real economic benefit of lowering your tax bill for the year. This morning I reviewed all of my client’s portfolios for opportunities to tax-loss harvest and took advantage of them wherever it made sense.
3) For the world traveler, this is a great time to visit England
The stock markets aren’t the only thing that fell today - so did the value of the British Pound. Relative to the US Dollar, the Pound fell almost 9%. This means that for Americans converting US Dollars to buy goods and services in the UK, everything just went on sale. If you’d been thinking about making a trip across the Atlantic, it should be even more compelling now!
Posted: June 24, 2016