Like most of us, you have probably been more focused on the ramifications of the health aspect of the COVID-19 crisis. But, given the media attention on the economics of the Coronavirus, it is natural to wonder if there is something you or we should be doing regarding your investment portfolio. So we thought it might be helpful if you had a better understanding of the day-to-day management of your Willow Creek investment portfolio.
What is Willow Creek Wealth Management Doing Behind the Scenes?
While our philosophy is to manage portfolios utilizing a disciplined long-term strategy based on rigorous academic research, we actually look at portfolios daily. Science has shown that what matters the most in determining the risk and return of a portfolio is asset allocation - the percentage of stocks (riskier growth driver) vs. bonds (less risky stabilizer). We have worked extensively with each of you to establish a portfolio mix that keeps in mind your financial goals, short and long-term cash flow needs, investment time horizon, and importantly, your tolerance for market volatility. There are two primary trading activities we utilize – portfolio rebalancing and tax loss harvesting. You may have heard these terms before, but what do they really mean, and why are they so valuable?
Rebalancing
Whether it is a market downturn or a bull market, Willow Creek frequently reviews your portfolio to make sure it matches your agreed-upon allocation (percentage of stocks vs. bonds). When the markets are volatile, we look more often but don’t necessarily take action. We learned decades ago that the most productive portfolio rebalancing is when an asset (a large U.S. stock mutual fund or a global bond fund, for example) moves outside a target range either up or down. It takes quite a bit to trigger an actual trade, but this allows us to take better advantage of market movements (momentum). Rebalancing, if pursued with a disciplined process and without emotion, is one of the best ways to systematically reinforce the tried and true success of buying low and selling high.
Tax Loss Harvesting
Another fundamental of successful investing is reducing costs people often forget about, such as capital gains taxes. Historically the markets have gone up, albeit in a jagged line, so a long-term investor with a well-diversified portfolio has made a profit. When you sell, you pay taxes on those gains in value. We diligently look for opportunities to offset those portfolio gains with losses. Here is how it works. We review your portfolio regularly, looking for assets that are currently out of favor in the markets (have paper losses). If it is appropriate for you and your tax situation, we sell those mutual funds or ETFs and buy something comparable. After observing the IRS wash sale rule (which is that you must hold a new investment for at least 30 days), we buy back the original fund if it is desirable to do so. Tax Loss Harvesting is something we do regardless of the state of the markets, but it is an especially valuable opportunity during market volatility, such as we are experiencing during the Coronavirus. The trick is to be sure each advisor is heavily involved, so we take into account your unique portfolio goals and tax situation.
How does Willow Creek Manage Withdrawals in a Down Market?
You may be reluctant to sell anything in a market like we are experiencing. After all, we continually advise you to stay-the-course and sell high and buy low. It just intuitively feels like the wrong time to sell. But this really relates more to selling out of an entire portfolio to cash. Your Willow Creek portfolio is designed to provide income in any market condition. When you ask for a withdrawal or if you have scheduled regular disbursements, we first look at any assets (mutual funds or ETF’s) that might have gains in value. If it is over the rebalancing target mentioned above, we will sell shares of that asset to fund the withdrawal. Often in a market downturn, all equity assets are down, so we look to the bond side of your portfolio. Bonds may not be yielding much right now in this low interest rate environment, but they historically have not experienced the kind of bear markets the equity side of your portfolio has. Think of your bonds as a safety net. We designed your portfolio to support you for years, so you don’t have to sell stock funds in a market downturn and lock in losses. There is also the possibility of using a margin account (borrowing on your investments so you don’t have to sell), but that depends on your particular situation and is a subject for another time.
Why Does Willow Creek Emphasize Staying the Course?
Instead of not wanting to sell anything, you may be very tempted to sell everything. Be aware that it is a conscious decision to stay-the-course with your portfolio in a wildly gyrating market. Doing “nothing” actually takes discipline and maybe even some courage. The brain is primarily made up of three parts -- primitive, emotional and cognitive. The first two parts are fast and robust. The cognitive brain is slower and wears out more quickly. This is why creating a meaningful financial plan is so important. You will likely have to fight through your fears to allow rational thinking to prevail. So, to wrap up, this is a very busy time for Willow Creek Wealth Management as we help you navigate through the crisis. You have already done your part by engaging with us on a thoughtful, all-weather, long-term plan. Please reach out to your advisor with any concerns you might have or if you would just like to chat. Our client conversations have been especially meaningful as we all adapt to a very different world.