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What to do in this Panicky Market - Part 2: Tax Loss Harvesting

August 25, 2015

The sky did not fall. The sun came up this morning. The markets even rebounded! -- at least as of the time of this writing at 1:30PM on August 25th. So now what? Rebalancing and tax-loss harvesting...

Tax-Loss Harvesting

Many clients will see activity in their accounts today. We have placed trades to realize tax-losses in non-retirement accounts and buy a suitable replacement security.  This tax-loss harvesting can help make lemonade out of the lemons the market turmoil threw at us.  

Below is a snippet from our tax-aware trading software. In this real-life example, the client can expect savings of $1,166 by making the tax-loss trades, which only cost $40 to make. Thus we make the trade.

Rebalancing

Some clients will also see rebalancing trades happening in their accounts. This is the beautifully disciplined process forcing to buy low (stocks) and sell high (bonds and managed futures). This is a simple idea that is often difficult to execute emotionally, since you're buying the security that just caused you so much financial and emotional pain.

Rebalancing can be done in many forms. Studies show that rebalancing by percentage variance tends to produce better results than rebalancing by calendar (quarterly, annually, etc.) For example, if a 20% variance is acceptable for a holding with a 10% target weight, we will buy the security if below 8% and sell if above 12%. Taking this approach can capitalize on the recent volatility whereas waiting to the end of the year could completely miss the opportunity.

Diversification and Portfolio Construction

In addition, yesterday provides a good lesson on diversification and why certain assets are included in your portfolio allocation. Stocks were down about 4%. Bonds preserved capital but were only slightly positive. However, the preferred managed futures fund held in client accounts (Ticker: QMHIX) was up more than 4%. (See: Should You Have Managed Futures In Your Portfolio.)

Summary

It's very possible that stocks will go down more. While the recent pull back happened with a rapid pace, pull backs are a normal part of investing. If history is a guide, we were overdue:

history of market declines

Stay disciplined. Focus on what you can control. Ignore the rest.

Kevin Kroskey, CFP®, MBA

 

This material is based on public information as of the specified date, and may be stale thereafter. True Wealth Design has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

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