Year In Review

Will Investors Stay The Course?

Addressing the growing tendency to go to cash

by Michael Lane

Mr. Lane is head of iShares U.S. Wealth Advisory at BlackRock. Visit www.blackrock.com.

For myself and most advisors I speak with, 2022 will be a year we would all like to forget. From soaring inflation to volatile markets to geopolitical uncertainty, this has been a tough year for investors across the board. Like many others, I look forward to turning the page of the calendar.

Many saw their portfolios suffer declines despite “doing all the right things,” like being well diversified. Others were hit harder if they stuck with growth sectors, which had worked so effectively for several years prior. Unfortunately, signs are pointing towards a recession and the Federal Reserve is still in interest rate hiking mode, meaning volatility and uncertainty could be with us for some time.

A year when virtually every asset class has declined has made for some very difficult conversations with clients, some of whom may be tempted to simply exit the market and move to cash. But the best course of action for most is to stay invested and remain focused on achieving long-term goals. The question is how to navigate the best path going forward.

There is an old saying “what seems like a curse may be a blessing” and that is what advisors should focus on as we head into 2023.

Three Silver Linings

While many clients have been dismayed by the decline of their portfolios this year, there are three silver linings to the current environment to consider:

1.) Tax loss harvesting opportunities


This is probably the best year in recent memory to take advantage of tax loss harvesting. As most advisors know, tax-loss harvesting is the act of selling an investment at a loss (based on price return, not total return). Those losses can then be used, dollar for dollar, to offset realized capital gains, or up to $3,000 per year in regular income. Investors may use sales’ proceeds to either buy similar investments to maintain current portfolio objectives or they can shift to an investment with a different goal, while making sure that they comply with the Wash Sale Rule. This Rule mandates that an investor cannot realize a loss on the sale of an investment and then buy a “substantially identical” security, beginning 30 days before and ending 30 days after a security sale.

Given the across-the-board declines in asset classes this year, there are many opportunities for tax loss harvesting. On the equity side, investors may have concentrated holdings in either individual securities or mutual funds. This is a chance to take a loss and possibly avoid a capital gain distribution from the mutual fund while diversifying the holdings and better aligning a portfolio’s risk and return characteristics with one’s goals. For those more tactical, investors may want to pair some traditional sector holdings with thematic exposures to take advantage of the opportunities presented by long-term transformational megatrends, such as genomics, robotics, and electric vehicles. Or investors may want to consider if their active mutual fund performance warrants the fees they are paying and whether the ETF may be a better long-term investment vehicle.

But even more importantly, this year has created an extraordinary opportunity in fixed income for tax loss harvesting. For as long as I can remember, when advisors and planners looked to use losses in a portfolio to offset taxable gains, they have looked to the equity side of a portfolio. This year, however, investors have seen steep declines in the face value of their bonds across asset classes from Treasuries to investment grade to high yield. Investors can consider taking some losses in parts of their bond portfolio to offset other taxes, but maintain access to fixed income with ETFs, and often be more precise with one’s credit and duration goals.

Since the price of bonds is inverse to the yield, the selloff in bonds this year has meant that yields are sharply higher, providing enticing opportunities for income-starved investors...

For most advisors, conversations around taxes begin in earnest after the new year. Typically, those discussions center on topics leading up to April 15, from IRA contributions to pulling together receipts for charitable contributions and other ways to limit clients’ tax impact. This year, advisors should be focused on taxes for the next few weeks to lock in the potential tax benefits before the end of the year.

2.) Bonds are back
 

Since the price of bonds is inverse to the yield, the selloff in bonds this year has meant that yields are sharply higher, providing enticing opportunities for income-starved investors. The yield on the 10-year U.S. Treasury is now around 4%. The 30-day SEC yield for the bonds constituting the Markit iBoxx USD Liquid Investment Grade Index is nearly 6%, as of this writing. While the Fed is not done raising rates, and there certainly could be more volatility in the bond market, the potential for more income is welcome news for investors long struggling with small bond yields and the paucity of income generated.

3.) Giving client portfolios a tune up


Given the above, the current environment can also be a catalyst to rethink the entire portfolio. There are many advisors and clients who would prefer to outsource the management of some parts of a portfolio to a professional fund manager. However, advisors should ask: Are the mutual funds in their client portfolios demonstrating consistent outperformance of the index? If so, are they providing true outperformance, or are they simply index proxies at higher fees? In such cases, advisors can consider blending ETFs with their existing funds, or building portfolios entirely of them.

In trying times like these, the importance of the ETF in helping advisors build stronger portfolios for their clients cannot be underestimated. Imagine trying to sell low yielding individual bonds at a reasonable price on the over-the-counter market for a number of clients while sourcing higher yielding ones. The ETF has made this significantly easier. Just as it is difficult to imagine our day to day lives without the ease and convenience of the cell phone and computer, it is hard to imagine the investing world without ETFs.

The growth of ETFs over the last twenty-five years or so has revolutionized the investing world. ETFs have helped advisors provide clients with access to wide segments of the investible universe and build stronger portfolios with the flexibility to make tactical adjustments along the way. This year has been a tough one for clients, but I’m a believer that ETFs can help position the portfolio for better days ahead.

Good Times/Bad Times

I’ve been fortunate to be part of this industry for 34+ years, and I’ve seen the good times as well as the bad ones, from the dot com crash to the financial crisis to the pandemic and its aftermath. I have confidence that the economy and markets will turn the corner, just as they did in earlier crises. And good advisors will be there to help their clients adjust to changing times and evolving markets.

We’ve all seen those ads where the advisor becomes like another member of a family, helping clients through their highs and lows. I’m sure I’m not the only one who finds those ads a bit cringy, but they do speak to a truth, namely, that clients need good advisors exactly for challenging times like these. Perhaps, then, the greatest opportunity for advisors right now is simply doing what they do best: helping clients navigate the investing world and keeping them on track to meet their goals. That means not panicking and selling out of the market unwisely. It means sticking to an investment plan while remaining flexible to adjust portfolios as needed to remain on course. And it means choosing a diverse mix of investment vehicles to meet those goals.