Trump’s victory has many concerned about market volatility
With the election of Donald Trump as U.S. president, many investors believe that a new era of political uncertainty is going to increase stock market volatility. And that leads to questions about whether it makes sense to rebalance portfolios, especially those that hold aggressive growth-oriented mutual funds and ETFs, to a more defensive tilt. Before hitting those sell buttons, stop for a moment, and think about what you actually mean by “defensive” and “aggressive,” and what making those changes would mean.
When I’m asked about “defensive” or “aggressive” funds, it usually has to do with relative levels of risk that an investor is willing to accept (with “volatility” being a key metric here).
Some fund categories can be construed as perhaps less risky and more “defensive” than others. For instance, money market funds are considered ultra-conservative and virtually risk-free, because they invest in highly liquid short-term government Treasury bills. Their unit values generally don’t fluctuate. The flip side is that money market funds pay out virtually nothing and may even produce a negative yield once you factor in tax and inflation.
Fixed-income funds are slightly more risky than the ultra-defensive money market funds, and typically provide a better return. That’s because bond prices and yields can change depending on both the prevailing level of interest rates and on interest rate expectations.
Equities can produce the largest gains and losses, and wide swings in volatility, and are thus are not generally considered “defensive” as an asset class (although within equity portfolios, the term “defensive” is frequently used to describe stocks that may be relatively less volatile, owing to their status as shares of large, blue-chip, dividend paying companies).
Playing it smart
Given the election results and all the subsequent media hype of recent days, you may be tempted to reallocate to “defensive” fixed-income funds and hold more cash in the form of money market funds. But that would be committing the cardinal portfolio sin of managing by emotion. No one can say what a Trump presidency will bring, any more than anyone could have said what an Obama presidency would bring when he was first elected.
In addition, by buying, selling, rebalancing, and reallocating, you’re not only generating costs in the form of brokerage commissions, but you may very well be inadvertently accumulating a hefty tax bill on the various buys and sells of your investments through the year. It all takes a sizeable chunk out of your investment returns and puts it in someone else’s pocket. There’s probably no other activity in the world where individuals will so eagerly perform a robbery on themselves.
It is far more prudent to approach your portfolio decisions from a perspective that looks at overall asset allocation, tax-efficiency, and cost. By this, I mean you should decide honestly about your level of risk tolerance. Then construct a diversified portfolio comprising safety, income, and growth assets in various proportions that reflect your risk comfort level. And stick with it. The key is to step back from the daily noise of the trading screen for long enough to take a look at your whole portfolio. And then ask yourself:
* Is it tax efficient? Am I attracting maximum tax with every transaction or am I minimizing the tax hit? Am I maximizing my use of Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans?
* Is it low cost? Am I using investment strategies that reduce my overall trading, transaction, and management costs, such as allocating at least some portion of my asset mix to low-cost exchange-traded funds?
* Am I mitigating risk? Am I diversifying my portfolio with enough non-correlated asset classes to suit my tolerance for risk? Am I using hedging or income-generating strategies with options? Or am I essentially “throwing darts” every day, and hoping for the best?
These are not particularly easy questions to answer, and you might just have to consult a financial advisor to help you get and keep your investments on the right – tax efficient – track. And that’s the best “defensive” strategy of all.
© 2016 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.