As a follow-up to last week’s commentary about the recent bout of downside volatility and how many stocks are performing worse than the major indexes, I want to discuss strategies this week. Specifically, actionable steps you can take between now and the end of the year.
None of these will be purely tactical in nature (e.g., “reduce your exposure to tech stocks”) because my crystal ball remains cracked. In fact, they don’t require a forecast to be correct at all. Rather, these action items are meant to be an outlet for your emotions by giving you something rational you can do now.
Accelerate Your Retirement Savings Contributions: If you’re making regular contributions to an individual retirement account (IRA), a Roth IRA or a similar type of account, consider making a single large contribution now instead of several smaller contributions between now and the end of the year (or by next April). Doing so will put extra cash into your account to invest should the markets dip further. Establish a decline percentage you’d invest contributed cash at if stocks fell that far (e.g., the S&P 500 index falls 15% from its high) and a date you’ll invest any excess cash in your account if the drop doesn’t occur by then (e.g., December 31). This is what I did in February with my then-remaining 2017 IRA contributions.
Go Bargain Hunting: If there is a stock you told yourself you’d buy if it got cheap enough, don’t just stand there, go look at it. See where its price is, what its valuation currently is and how sound its underlying fundamentals are. While it’s very hard to know where the bottom will be in advance, if you don’t look at the stock at least periodically, your odds of catching it while it’s on sale will be very low.
Review Your Tax Exposure: We don’t think investors should let the tax tail wag the portfolio dog, but if you have stocks that you were considering parting with or that could violate your sell rules if their third-quarter earnings disappoint, it makes sense to take inventory of your tax situation. Losses offset gains and you can deduct up to $3,000 of net losses (losses in excess of gains) per tax year.
Consider a Roth IRA Conversion: The Tax Cuts and Jobs Act (TCJA) makes it cheaper for many people to convert a traditional IRA to a Roth IRA because of the lowered marginal tax rates. Assessing your tax situation now will give you an estimate of how much you can move over to a Roth without being bumped into a higher tax bracket. Plus, if you do a conversion when your IRA is below its peak balance, you can convert a larger percentage of assets for the same dollar amount. Just keep in mind that Roth IRA conversions are permanent; the TCJA outlawed Roth IRA recharacterizations.
If Nearing Retirement, Build a Cash Bucket: One of the biggest financial threats facing new retirees is a bear market occurring within a few years of retiring. Having an allocation to cash, cash equivalents and/or high-quality, short-term bonds that equals to two to five years of estimated withdrawals will allow you to avoid touching your equity allocation while stock prices are down. I’m not expecting a bear market to start in the short term, but eventually one will happen simply because bear markets periodically occur.
Check Your Portfolio Allocations to See If They’re Still Close to Target: If you haven’t looked at your portfolio’s weightings to various asset classes in a while, now is a good time to do so. If they’re off-target by, say, five or 10 percentage points, adjust them back to target.
Ladder Bonds and CDs: If it’s rising interest rates that have you concerned, consider diversifying the duration of your cash and bond allocations. Buying bonds and certificates of deposit (CDs) of varying maturities allows you to pivot to future rate environments without relying on potentially incorrect forecasts. As your shorter-term investments mature, you’ll be able to reinvest the proceeds at the then-prevailing yields while still having exposure to the current longer-term rates. Though the monetary policy is being tightened now, it will likely be loosened whenever the next recession occurs.
Stop Looking at the Market So Much: While this may sound silly, the less frequently you look at the stock market, the less volatile it will seem. Despite the 24/7 flow of news and information, you can get away with looking at your portfolio less frequently than you may think. AAII’s model portfolios have realized long-term outperformance by mostly limiting portfolio changes. Changes, when there is a transaction to be made, occur in our Stock Superstars Report just once a month and in our Model Shadow Stock Portfolio just once every three months.
- Capital Pains: Rules for Capital Losses – This article discusses the rules for capital gains and losses and how the two can offset each other.
- The Level3 Withdrawal Strategy to Maximize Your Long-Term Wealth – James Cloonan and John Bajkowski explain how a cash bucket can be used in a broader retirement withdrawal strategy.
- Learning From the Mistakes Made by Legendary Investors – Even the best-known investors have made mistakes, including the 10 common ones highlighted in this article.
- Companies Surpassing Industry Norms – These 15 stocks are cheaper than their peers yet are more profitable and have lower levels of proportionate debt.
No changes were made to the Model Shadow Stock Portfolio. The next quarterly review will take place at the end of November.
The market turned bearish for small-company stocks during September, with the Model Shadow Stock Portfolio giving up 6.7% during the month and dropping back into negative territory for the year, with a 1.3% loss. The Vanguard Small Cap Index fund (NAESX) lost 1.5% during the month, while the DFA U.S. Micro Cap fund (DFSCX) lost 2.4% during September. The S&P 500 index, as measured through the Vanguard S&P 500 Index fund (VFINX), gained 0.6% during September and was up 10.4% for the year.
Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 15.4% versus the Vanguard 500 Index fund’s gain of 9.7% per year on average. Over the same period, the Vanguard Small Cap Index fund posted an average annual gain of 10.4%.
Our Investor Conference will be held next Friday through Sunday. Those of you who will not be attending the conference can still access audio recordings of the speakers and their presentations.
We’re going to start moving into the heart of third-quarter earnings season with approximately 160 members of the S&P 500 scheduled to report. Included in this large group are Dow Jones Industrial components 3M Co. (MMM), Caterpillar Inc. (CAT), McDonald’s Corp. (MCD) and United Technologies (UTX) on Tuesday; Boeing Co. (BA), Microsoft Corp. (MSFT), Verizon Communications Inc. (VZ) and Visa Inc. (V) on Wednesday; and Intel Corp. (INTC) and Merck & Co. (MRK) on Thursday.
The week’s first economic reports will be the September new homes sales and the Federal Reserve’s periodic Beige Book report, both of which will be released on Wednesday. Thursday will bring September durable goods orders, September pending home sales and September international trade data. The University of Michigan’s final October consumer sentiment survey and the first revision to third-quarter GDP will be released Friday.
Five Federal Reserve officials will make public appearances: Minneapolis president Neel Kashkari and Chicago president Charles Evans on Tuesday; Atlanta president Raphael Bostic on Tuesday and Wednesday; St. Louis president James Bullard on Wednesday; and Cleveland president Loretta Mester on Wednesday and Thursday.
The Treasury Department will auction $38 billion of two-year notes on Tuesday, $19 billion two-year floating rate notes and $39 billion of five-year notes on Wednesday and $31 billion of seven-year notes on Thursday.
- Future Retirees at Greater Risk of Hardship
- Learning From the Mistakes Made by Legendary Investors
- Grasshoppers and Ants in Retirement
More than a third of individual investors described their outlook for stocks as bearish for the second consecutive week. The latest AAII Sentiment Survey also shows a decrease in neutral sentiment and an increase in optimism.
Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 3.3 percentage points to 33.9%. Even with the increase, optimism remains below its historical average of 38.5% for the second consecutive week and the fifth time in six weeks.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, pulled back by 2.9 percentage points to 31.0%. The decrease was not large enough to prevent neutral sentiment from remaining at or above its historical average of 31.0% for the 33rd time in the past 35 weeks.
Bearish sentiment, expectations that stock prices will fall over the next six months, declined by a modest 0.4 percentage points to 35.0%. Pessimism is above its historical average of 30.5% for the fifth time in six weeks.
This week marked only the third time this year when pessimism exceeded 33% on consecutive weeks. The other two times were March 28–April 11 and June 27–July 4.
At current levels, all three indicators are within their typical historical ranges.
Some AAII members have been anticipating a decline in stock prices prior to the recent downward volatility; whether the pullback is steep enough to prompt them to act remains to be seen. Tariffs and the possibility of an escalating trade war remain front and center on the minds of many individual investors. Also influencing sentiment are Washington politics (including President Donald Trump), midterm elections, economic growth, valuations and corporate profits.
This week’s special question asked AAII members how they perceived the performance of the stocks they own or follow relative to the year-to-date returns of the S&P 500 index and the Nasdaq composite. Responses were mixed. One-third of respondents (33%) say their returns have been worse. A slightly smaller group of respondents (31%) describe their returns as approximately matching that of the S&P 500 and the Nasdaq. Just 16% of respondents say they are outperforming the two major indexes. Some respondents say they are beating one index but not the other, or that some of their stocks are outperforming while others are underperforming.
Here is a sampling of the results:
- “I have a modest excess of value stocks and they are underperforming.”
- “Better than both due to diversification across sectors and focus on income-producing investments.”
- “Some stocks are up, and some are down; that is why you diversify.”
- “With my low exposure to technology, my return is lower. But I have cash ready to buy with when the occasional bear market occurs.”
- “Highly volatile just like the S&P and the Nasdaq.”
Bullish: 33.9%, up 3.3 points
Neutral: 31%, down 2.9 points
Bearish: 35%, down 0.4 points
Local Chapter Meetings
October 11, 2018 It’s Been a Tougher Year Than the Headline Numbers Suggest
October 4, 2018 Diversification Cushions the Blow of Drawdowns, But at a Cost
September 27, 2018 Increasingly, Just One Analyst Is Behind a Stock’s Long-Term Earnings Forecast
September 20, 2018 SEC to End Five-Cent Spreads on Small-Company Stocks