Individual investors can’t do much to improve the miserable performance of the stock market, but they may be able to help their own portfolios.
Thanks to the severe bear market of the last year or so – and a 10-year stretch in which stocks have lost ground over all – some planners say investors have a rare opportunity: they can completely refashion their portfolios with little or no tax consequence.
“This is your chance now to put your money where it really needs to go – for the long run,” said Mike Scarborough, president of Scarborough Capital Management, an investment advisory firm in Annapolis, Maryland.
These makeover opportunities, of course, are a consequence of losses practically everywhere you turn. No one wanted this carnage to happen, but now that it has, here are two ways to make something useful out of it:
Broaden your portfolio
“There’s no better time to diversify than when everything is down,” Scarborough said.
A prime example for American investors is foreign stocks. He noted that before this downturn, when overseas stocks were soaring, risk-averse American investors faced a quandary. “You could either diversify knowing full well that you were paying high prices, or you could forgo that exposure, which meant that you might be adding volatility to your portfolio over the long run,” he said.
“This conundrum no longer exists,” he added, because stocks outside the United States have sunk even more than American-listed shares, bringing the foreign valuations down to earth.
The price-to-earnings ratio for foreign stocks in developed markets, for example, has tumbled to around 10, on average, from nearly 14 near the market’s peak in 2007, according to Standard & Poor’s Equity Research. (This is based on consensus forecast earnings for the coming 12 months.) P/E ratios for emerging-markets stocks have fallen even more – to 8.5 from 14.5 near the peak.
Because valuations globally have come down significantly, said Alec Young, an S.& P. equity strategist, “this is a much better time to be looking at these markets.”
Despite all the attention on international markets earlier in this decade, most individual investors still have only slim stakes abroad. According to figures tracked by Hewitt Associates, 12 percent of the equity portfolio of the typical 401(k) investor is in foreign shares. That’s about half the level that many planners recommend.
Real estate investment trusts are another example of once-frothy assets that have fallen significantly – and that can be used for diversification.
Over the last 20 years, investors would have slightly improved performance and reduced volatility by shifting 10 percent of their equity stake into real estate investment trusts, or REITs, according to Morningstar. Yet it was hard to justify moving to REITs earlier this decade, when Wall Street was euphoric about them.
REITs have fallen more than 40 percent over the past year, on average, and while they still pose significant risks in a recession and real estate downturn, they may be worth a closer look.
Lower your expenses
For years, investors have been told that a simple way to bolster long-term performance is to invest through low-cost mutual funds or exchange-traded funds because fund expenses reduce returns dollar for dollar. But it hasn’t always been that simple for older investors to replace their holdings with less expensive funds. That’s because it means selling your existing funds, potentially setting off capital gains taxes.
The sharp decline in the stock market has taken care of much of that problem. Although there are exceptions, it’s likely that market losses will mean lower capital gains taxes if you sell your holdings now, said Stuart Ritter, a financial planner at T. Rowe Price in Baltimore.
Over the past decade through Thursday, 52 percent of all U.S. stock funds and 77 percent of all large-capitalization stock funds have lost money, according to Morningstar. And some losses have been substantial. Consider Putnam Growth Opportunities. This fund is down 7.3 percent a year, on average, for that period.
Mutual fund losses are even more widespread over the past five years: 91 percent of all American stock funds fell during this period. So if you bought high-cost funds, you will likely be able to sell them with little or no tax consequence and move into low-cost alternatives.
This strategy even works for investors already in reasonably inexpensive funds. Say you’re now in a large-cap fund like Vanguard U.S. Growth; its annual expense is a modest 0.43 percent. But because this fund is down over the past decade, you might easily sell it – capturing the tax loss, which can be used to offset gains or up to $3,000 in ordinary income – then swap into a cheaper option like an index fund that tracks the S.& P. 500.
Examples are Vanguard 500 Index, which charges 0.15 percent annually, and Fidelity Spartan 500, 0.10 percent. You might also consider ETF’s tracking the broad market — like iShares S.& P. 500, at 0.09 percent.
Buying and selling ETF shares, however, requires brokerage commissions. So investors who wish to put small amounts to work every month or quarter may want to consider a traditional index fund or actively managed portfolio that doesn’t charge sales commissions.
“It’s pretty obvious that there are a lot of opportunities in this market,” Scarborough said. The key is not to delay so long that the markets begin to recover, closing this window of opportunity.
1 comment:
Bear market gives investors chance to regroup
By Paul J. Lim
1 February 2009
Individual investors can’t do much to improve the miserable performance of the stock market, but they may be able to help their own portfolios.
Thanks to the severe bear market of the last year or so – and a 10-year stretch in which stocks have lost ground over all – some planners say investors have a rare opportunity: they can completely refashion their portfolios with little or no tax consequence.
“This is your chance now to put your money where it really needs to go – for the long run,” said Mike Scarborough, president of Scarborough Capital Management, an investment advisory firm in Annapolis, Maryland.
These makeover opportunities, of course, are a consequence of losses practically everywhere you turn. No one wanted this carnage to happen, but now that it has, here are two ways to make something useful out of it:
Broaden your portfolio
“There’s no better time to diversify than when everything is down,” Scarborough said.
A prime example for American investors is foreign stocks. He noted that before this downturn, when overseas stocks were soaring, risk-averse American investors faced a quandary. “You could either diversify knowing full well that you were paying high prices, or you could forgo that exposure, which meant that you might be adding volatility to your portfolio over the long run,” he said.
“This conundrum no longer exists,” he added, because stocks outside the United States have sunk even more than American-listed shares, bringing the foreign valuations down to earth.
The price-to-earnings ratio for foreign stocks in developed markets, for example, has tumbled to around 10, on average, from nearly 14 near the market’s peak in 2007, according to Standard & Poor’s Equity Research. (This is based on consensus forecast earnings for the coming 12 months.) P/E ratios for emerging-markets stocks have fallen even more – to 8.5 from 14.5 near the peak.
Because valuations globally have come down significantly, said Alec Young, an S.& P. equity strategist, “this is a much better time to be looking at these markets.”
Despite all the attention on international markets earlier in this decade, most individual investors still have only slim stakes abroad. According to figures tracked by Hewitt Associates, 12 percent of the equity portfolio of the typical 401(k) investor is in foreign shares. That’s about half the level that many planners recommend.
Real estate investment trusts are another example of once-frothy assets that have fallen significantly – and that can be used for diversification.
Over the last 20 years, investors would have slightly improved performance and reduced volatility by shifting 10 percent of their equity stake into real estate investment trusts, or REITs, according to Morningstar. Yet it was hard to justify moving to REITs earlier this decade, when Wall Street was euphoric about them.
REITs have fallen more than 40 percent over the past year, on average, and while they still pose significant risks in a recession and real estate downturn, they may be worth a closer look.
Lower your expenses
For years, investors have been told that a simple way to bolster long-term performance is to invest through low-cost mutual funds or exchange-traded funds because fund expenses reduce returns dollar for dollar. But it hasn’t always been that simple for older investors to replace their holdings with less expensive funds. That’s because it means selling your existing funds, potentially setting off capital gains taxes.
The sharp decline in the stock market has taken care of much of that problem. Although there are exceptions, it’s likely that market losses will mean lower capital gains taxes if you sell your holdings now, said Stuart Ritter, a financial planner at T. Rowe Price in Baltimore.
Over the past decade through Thursday, 52 percent of all U.S. stock funds and 77 percent of all large-capitalization stock funds have lost money, according to Morningstar. And some losses have been substantial. Consider Putnam Growth Opportunities. This fund is down 7.3 percent a year, on average, for that period.
Mutual fund losses are even more widespread over the past five years: 91 percent of all American stock funds fell during this period. So if you bought high-cost funds, you will likely be able to sell them with little or no tax consequence and move into low-cost alternatives.
This strategy even works for investors already in reasonably inexpensive funds. Say you’re now in a large-cap fund like Vanguard U.S. Growth; its annual expense is a modest 0.43 percent. But because this fund is down over the past decade, you might easily sell it – capturing the tax loss, which can be used to offset gains or up to $3,000 in ordinary income – then swap into a cheaper option like an index fund that tracks the S.& P. 500.
Examples are Vanguard 500 Index, which charges 0.15 percent annually, and Fidelity Spartan 500, 0.10 percent. You might also consider ETF’s tracking the broad market — like iShares S.& P. 500, at 0.09 percent.
Buying and selling ETF shares, however, requires brokerage commissions. So investors who wish to put small amounts to work every month or quarter may want to consider a traditional index fund or actively managed portfolio that doesn’t charge sales commissions.
“It’s pretty obvious that there are a lot of opportunities in this market,” Scarborough said. The key is not to delay so long that the markets begin to recover, closing this window of opportunity.
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