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How to Minimize the Damage From the Current Sell-Off

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Last week U.S. stocks declined every day but Monday. Friday’s 500-plus point drop in the Dow prompted two incoming calls from clients asking my opinion; I’m sure many of you received similar calls. In this post, I’ll share a few thoughts on how to minimize the damage and even boost account performance during times such as these. 

It’s good to have some cash in the account which can be deployed into stocks at some point. I recall a saying from years ago that cash is king. With today’s meager rates, I’d say cash is more like a lowly servant than a king. And bonds? Well, we all know what will happen to them when interest rates rise. That said, how do you stay on top of client accounts to make sure they hold up relatively well, especially if this decline has legs? 

Model Portfolios

Model portfolios are one method, but there are some things to consider with models. Let’s say you assign a specific model to the account of John and Mary Smith, which will be rebalanced every 6 or 12 months. If the rebalancing creates transaction fees, this must be factored into the decision. Obviously, you wouldn’t want to buy (or sell) a few thousand dollars of a security if it would generate a transaction fee. To avoid the impact of the fee you can establish a minimum dollar amount (or percentage) to be rebalanced. You could also use no-transaction-fee (NTF) funds to solve the issue. What if stocks are declining and your scheduled rebalance date is several months away? 

Typically, you can set alerts to remind you if the portfolio is out of alignment with the model by a certain percentage. Personally, I recommend rebalancing whenever stocks rise or decline by some predetermined percentage.

For instance, if you don’t rebalance during a stock-market decline, when stocks reach their bottom and start to rebound, the portfolio won’t perform as well as it would’ve if you had rebalanced. This is because the percentage allocated to stocks in the portfolio gets smaller as stock prices fall. And when stocks finally reach bottom, the portfolio’s stock allocation may even be less than the model’s target. It may actually be better to increase the allocation to stocks as they decline.

Besides the obvious benefit of dollar-cost-averaging, when the rebound occurs, the portfolio will be more heavily weighted in stocks, which will provide a boost in performance. It may also be beneficial to reduce the portfolio’s stock percentage as the market rises. However, this could work against you if the rise continues for an extended period of time.

The principal here is simple. As stocks rise, risk increases and the probability of positive future returns decreases (courtesy of Benjamin Graham). 

We’ll continue the discussion next week. 

Until then, thanks for reading and have a great week!

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