Understanding Risk Management Techniques: Protecting Your Portfolio in Times of Uncertainty
Portfolio risk can have a few different meanings, but the one we will review today is the risk that an investor’s portfolio could lose money. Different investors will have differing levels of risk tolerance. Portfolio Diversification Portfolio diversification is about investing across a range of investments and investment types. The idea is that different types of investments react differently to similar economic and market conditions. Having an appropriate mix of various types of investments can help minimize losses in your portfolio in that generally some portion of your portfolio will do well across the full range of market conditions. The correlation between different types of investments is a key element of diversification. For example, according to Morningstar1, the correlation between U.S, large cap growth stocks and the following asset classes is: U.S. small cap value stocks 71.8% Foreign industrialized markets stocks 51.7% U.S. investment grade bonds 18.9% Cash 2.3% Commodities 12.4% What these percentages signify is the percentage of the price movements in securities in these asset classes are tied to the movement of process for U.S. large cap growth stocks. While the correlation with U.S. small cap value stocks is fairly high at 71.8%, the correlation with cash is ultra-low at 2.3%. Essentially, these two asset classes have virtually no correlation with each other. In the case of cash, which could be represented by a savings account, CDs, or a money market account, this makes total sense, as cash is considered the ultimate safe haven asset during periods of stock market volatility. Asset Allocation Asset allocation is the next step in portfolio diversification. A formal asset allocation strategy will set target allocations for various asset classes such as stocks, bonds, cash, alternatives and others. Beyond these broad asset classes, your allocation will generally be more granular with sub-asset classes such as large, small and mid-cap stocks, foreign stocks as well as stocks that are value- or growth-oriented. This sub-asset class approach also holds true with bonds and other types of investments. A famous study by Gary Brinson attributed 90% of the performance of an investment portfolio to its asset allocation.2 Over the years, other studies have attributed more or less of the percentage of a portfolio’s return to asset allocation, but the percentage is still a high one. Your asset allocation should be an outgrowth of your overall financial planning objectives and strategies. The allocation should be based on your age, your risk tolerance, and your time horizon for the use(s) of the money. Generally, you will want to look at your asset allocation on any overall basis across the various accounts you may have, including taxable accounts or retirement accounts like an IRA or a 401(k). However, it can make sense to have slightly different asset allocations for different accounts if they will be tapped for income at various times for different purposes. Portfolio Rebalancing Portfolio rebalancing involves periodically adjusting the level of the various holdings in your portfolio to ensure that your overall portfolio asset allocation is in line with your target asset allocation. This may involve selling some holdings and using the proceeds to purchase securities in asset classes that are underweight. Another rebalancing tactic is to direct new money that you add to one or more accounts into holdings in those underweight asset classes. Giving shares of appreciated securities to a charity or adding them to a donor advised fund is another way to rebalance. For those who can itemize on their taxes, this offers a tax deduction. In addition, you will not be subject to any capital gains taxes that would arise if you had sold the shares outright. Portfolio rebalancing should be done on a regular basis, but not too frequently. Annually, semi-annually or quarterly might be appropriate, but daily or weekly would generally not be. When rebalancing you should consider the tax implications of shares being sold, both for gains and losses, if the shares are in a taxable account. Tax-loss harvesting, or using realized losses on shares to offset realized gains elsewhere in your portfolio, is a good consideration. Another consideration for rebalancing is to look at which accounts (taxable or tax-advantaged) to use for these transactions. Conclusion While most of us invest to grow the value of our assets, our desire for growth needs to be balanced against the need to protect our investments against downside risk. It takes time to regain the former level of our investments after a down year for the markets. Contact your Wedbush financial advisor to discuss achieving the right balance between upside growth potential and the proper level of risk management for your portfolio. 1Morningstar: https://admainnew.morningstar.com/webhelp/Practice/Plans/Correlation_Matrix_of_the_14_Asset_Classes.htm The information provided in the link above are an example of the average diversified portfolio at a certain point in time. The data should not be used to predict or estimate or mimic changes, but interpreted as a generic overview of what an average diversification looks like. That example of diversification might not suitable for everyone. Please discuss with your advisor what is suitable in your circumstances. The data provide from companies, and organizations that may be referenced on this page are not affiliated with Wedbush Securities or any of its affiliates. Opinions mentioned are that of the third-party and not of Wedbush Securities, the financial adviser and/registered representative, or any of our affiliates. 2Gary P. Brinson, L. Randolph Hood, & Gilbert L. Beebower. (1986). Determinants of Portfolio Performance. Financial Analysts Journal, 42(4), 39–44. http://www.jstor.org/stable/4478947 Disclosure Securities and Investment Advisory services offered through Wedbush Securities, Inc. Member NYSE / FINRA / SIPC. Wedbush Securities does not provide tax or legal advice. Please consult your tax or legal advisor. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific
Smart Investing for College Savings: Planning for Your Children’s Education
The cost of college is rising on a fast and continual basis. According to data from U.S. News and World Report1, the average cost for tuition and fees for the 2023-2024 school year are at: Private colleges and universities: $42,162 Out-of-state students at public universities: $23,630 In-state students at public universities: $10,662 Note this includes tuition only. When you add in room and board, books and other costs the total would exceed $90,000 at the most expensive elite private universities this school year.1 Financial aid and scholarships can help to mitigate these costs if your child qualifies, but you should not count on this. Here are some smart investing ideas to plan for your children’s college and higher education expenses. 529 Plans A 529 plan is a tax-advantaged college savings plan offered by all 50 states. These plans were originally limited to paying for college costs, but recent legislation has expanded allowable uses to include K-12 costs in some cases as well as apprenticeship programs and trade schools. There are two main types of 529 plans: Education savings accounts allow for tax-free withdrawals for qualified educational expenses. Prepaid tuition plans allow the account beneficiary to lock in current tuition rates at specified universities. These plans often result in the student paying a lower rate for tuition than the current rate at the time they attend. Qualified educational expenses generally include costs like tuition, room and board, books, fees and related costs. The Secure Act followed by Secure 2.0 allows money left in a 529 account to be used to pay off student debt both by the account beneficiary and certain family members. Additionally, up to $35,000 can be transferred to a Roth IRA in the name of the beneficiary as well. Custodial Accounts A custodial account allows a parent or other adult to gift money to an account established for a minor beneficiary. Uniform Gift to Minors Act (UGMA) accounts were the original type of custodial account, this was followed by the Uniform Transfer to Minors Act (UTMA). These accounts are normally opened at a bank or brokerage firm and can be invested in a full range of financial investments such as stocks, bonds, mutual funds, ETFs and others. UTMA accounts, which have largely superseded UGMA accounts across the country, allow for investments in real assets such as real estate as well. A custodial account reverts to the control of the minor beneficiary once they reach the age of majority. Any gifts to the custodial account are irrevocable, meaning the adult donor cannot reverse the gift once it has been made. Custodial accounts can be used for college costs, but can also be used for just about any other type of expense as long as the expense is made for the benefit of the minor beneficiary. Custodial accounts allow for a wider range of investments than a 529 plan, but investments in a custodial account can limit the minor beneficiary’s access to financial aid in some cases, and can have tax consequences for the minor and/or the parents as well. Roth IRAs Contributions to a Roth IRA can be withdrawn at any time tax-free and this money can be used to fund college expenses. This applies to a Roth IRA owned by a parent or the child. In the case of a child, if they have earned income from a part-time job they can contribute up to the annual contribution or the amount of their earned income, whichever is lower. The amount of their contributions can be withdrawn to use for college expenses while leaving the money from any investment earnings in the account to continue to grow tax-free. A nice thing about a Roth IRA is that the account holder will have a wide range of potential investments to choose from. Withdrawal of money attributable to account earnings prior to age 59 ½ would be subject to a penalty and most likely to taxes so it is important to only withdraw money that is attributable to contributions to the account. CDs and Savings Bonds CDs are ensured savings vehicles offered by banks, credit unions and many brokerage firms. They run for a set term of a few months out to ten years in some cases. These accounts are federally insured and can be a good option with today’s interest rates. Note there is a penalty for early withdrawals. Savings bonds are offered through the U.S. Treasury. Series EE and I bonds are both solid options. EE bonds are guaranteed to double in value within 20 years. I bonds are designed to protect against inflation and currently offer a very attractive rate. Both types of bonds are guaranteed by the U.S. government, and you can start with an investment of as little as $25. Get an Early Start Whether you use one of these options or another savings vehicle including just a regular investing account, your best bet is to start early and put away money for your child’s education on a regular basis. We must assume that college costs will keep rising, so a longer investing horizon helps. Talk to your Wedbush financial advisor about the best ways to save for your child’s education. 1Nasdaq: https://www.nasdaq.com/articles/how-much-does-it-cost-to-attend-one-of-2024s-best-colleges Disclosure Securities and Investment Advisory services offered through Wedbush Securities, Inc. Member NYSE / FINRA / SIPC. Wedbush Securities does not provide tax or legal advice. Please consult your tax or legal advisor. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.