What's a good way to protect a long term ETF portfolio?
August 14, 2013 7:43 AM Subscribe
The reason I turn to ask mefi here is that most of the resources I find on the webs are catered to more active investors. I've spent the last few years dollar-cost averaging into several different ETFs, indexed to large markets. Since the ETF's are products of my brokerage account, I can trade them for free. I haven’t done any selling, and have some decent returns as things stand now.
The real question now is, what is the best practice for defending my portfolio against another 2008? My thoughts are that the smartest and most conservative approach is a stop-loss adjusted monthly to about 15% off the high... and then start the process again... buying in incrementally to take advantage of either falling stock prices or a slow recovery.
I'm not looking to outsmart the market here... just the best way to play it safe. Best help for me would be broad concepts about tax implications (you'll lose me with anything too technical), thoughts about 'flash crashes,' or any other ideas.
Thanks folks!
Unless the very broad economy is stormy, I wouldn't try to time the market if you're a casual investor. Having a stop loss at 15% might save you if it keeps falling but it might also cost you if there's a temporary dip and it rebounds 3% the next day and goes back up.
As far as taxes, if you're saving in terms of retirement, everything you can get into a tax shelter (either conventional or Roth) should be in one. That way you don't have a tax headache when you cash out - in the case of the former, whatever money you take out is taxed as if it was income that year and in the latter there's no taxes whatsoever (other than what you paid before you put the money in).
Otherwise you pay taxes on the difference between what you bought it for and what you sold it for. Right now that tax rate is low but it could go up. The rate is different for short term holdings and long term holdings. If you have 5 shares of an ETF bought in 2010 and 5 shares bought last month and want to sell 5, some brokerages let you specify which ones you sell so you can maximize tax savings. Some of the ones with free ETFs do not - whatever you bought most recently gets sold.
If the capital gains tax goes up significantly, it might be worth considering selling your older ETFs that have the most gain to minimize tax impact.
posted by Candleman at 8:17 AM on August 14, 2013
As far as taxes, if you're saving in terms of retirement, everything you can get into a tax shelter (either conventional or Roth) should be in one. That way you don't have a tax headache when you cash out - in the case of the former, whatever money you take out is taxed as if it was income that year and in the latter there's no taxes whatsoever (other than what you paid before you put the money in).
Otherwise you pay taxes on the difference between what you bought it for and what you sold it for. Right now that tax rate is low but it could go up. The rate is different for short term holdings and long term holdings. If you have 5 shares of an ETF bought in 2010 and 5 shares bought last month and want to sell 5, some brokerages let you specify which ones you sell so you can maximize tax savings. Some of the ones with free ETFs do not - whatever you bought most recently gets sold.
If the capital gains tax goes up significantly, it might be worth considering selling your older ETFs that have the most gain to minimize tax impact.
posted by Candleman at 8:17 AM on August 14, 2013
If by "buying in incrementally" you mean investing less than you could, there are two problems with that: you are still trying to outsmart/outguess the market, and there is evidence (contrary to the dollar cost averaging myth, whose real benefit is the regular investing discipline it imposes) that putting in all your money at the beginning yields better performance than putting it in incrementally. Typically people who are worried about stocks falling in the short or medium term shift some money to bonds, the theory being that diversification among asset classes (stocks, bonds, etc.) reduces overall portfolio volatility.
posted by Dansaman at 8:18 AM on August 14, 2013
posted by Dansaman at 8:18 AM on August 14, 2013
Your best defense is to be diversified so that if equities tank, something else in you portfolio (typically bonds) rises to help minimize the losses. Personally, I'm spread across US equities, Intl equities, REITs, cash, and bonds - all via low cost Vanguard mutual funds. I did that after 2008, so I can't speak to how it will perform if US equities drop 30% over a month sometime soon.
posted by COD at 8:39 AM on August 14, 2013
posted by COD at 8:39 AM on August 14, 2013
Conventional wisdom (backed by lots of empirical data) suggests that trying to time the market is a fool's errand and really not suitable particularly to typical long-term/retirement investors. If you did choose to try to time the market via technical metrics, a stop-loss approach to your entire portfolio would probably be an awful way to do this. There are negative tax implications, you will be locking in losses, and most importantly how do you know when the market hits bottom and you need to get back in -- what if 15% turns out to be the bottom of the dip. There are a laundry list of better and more complex technical indicators that people may use for this purpose, but there's no sure fire way to predict the timing of a 2008 like event.
By way of the available data, if you look at the S&P since the bottom in early 2009, we appear to have been in a secular bull market recovery since that time. Over the last 4 years however, there have already been 2 market corrections with drops in excess of 15% (4/29/11-8/19/11; 4/23/10-6/2/10), and several more corrections around the magnitude of 10%. Had you sold during those 2 mentioned dips, you would have locked in losses, paid taxes on whatever you gained over your tax basis (if the money wasn't in tax-privileged accounts), and been left with trying to decide when to put the money back into the market -- all the while, losing out on the interim growth with your money on the sidelines.
Now take a look at how the market performed around the last crash. The S&P peaked at around 1562 in 10/2007, and with a 15% stop-loss approach to the S&P you would have sold around 1/2008 at about 1325. Then look at what happened between 3/2008 and 5/2008 -- an aggressive rally of over 10% growth in just a 2 month period!! Would you have known that that rally turned out to be a "dead cat bounce" before the bottom dropped out on the market? Would you have kept your money out of the market despite an impressive rebound? If you bought in right around that point, you would have lost even more than just keeping your money in the market through the whole crash.
Ultimately, your best defenses on the long-term horizon are: regular consistent investment (dollar-cost averaging), appropriate diversification in asset classes with limited correlation, and adjusting the overall risk of your asset allocation (typically increasing bonds/fixed-income vs. equities) as your time horizon narrows (approaching retirement).
posted by drpynchon at 10:15 AM on August 14, 2013
By way of the available data, if you look at the S&P since the bottom in early 2009, we appear to have been in a secular bull market recovery since that time. Over the last 4 years however, there have already been 2 market corrections with drops in excess of 15% (4/29/11-8/19/11; 4/23/10-6/2/10), and several more corrections around the magnitude of 10%. Had you sold during those 2 mentioned dips, you would have locked in losses, paid taxes on whatever you gained over your tax basis (if the money wasn't in tax-privileged accounts), and been left with trying to decide when to put the money back into the market -- all the while, losing out on the interim growth with your money on the sidelines.
Now take a look at how the market performed around the last crash. The S&P peaked at around 1562 in 10/2007, and with a 15% stop-loss approach to the S&P you would have sold around 1/2008 at about 1325. Then look at what happened between 3/2008 and 5/2008 -- an aggressive rally of over 10% growth in just a 2 month period!! Would you have known that that rally turned out to be a "dead cat bounce" before the bottom dropped out on the market? Would you have kept your money out of the market despite an impressive rebound? If you bought in right around that point, you would have lost even more than just keeping your money in the market through the whole crash.
Ultimately, your best defenses on the long-term horizon are: regular consistent investment (dollar-cost averaging), appropriate diversification in asset classes with limited correlation, and adjusting the overall risk of your asset allocation (typically increasing bonds/fixed-income vs. equities) as your time horizon narrows (approaching retirement).
posted by drpynchon at 10:15 AM on August 14, 2013
COD: I'm spread across US equities, Intl equities, REITs, cash, and bonds - all via low cost Vanguard mutual funds
In fact, just buying VTI, VYM, VXUS, and BND via an automated purchase program like the one offered by Capital One 360 (ugh, formerly ING) is a solid, no-hassle way to go.
As others have said, stop-loss sell orders at fixed thresholds are a bad idea for any specific threshold.
posted by RedOrGreen at 11:56 AM on August 14, 2013
In fact, just buying VTI, VYM, VXUS, and BND via an automated purchase program like the one offered by Capital One 360 (ugh, formerly ING) is a solid, no-hassle way to go.
As others have said, stop-loss sell orders at fixed thresholds are a bad idea for any specific threshold.
posted by RedOrGreen at 11:56 AM on August 14, 2013
I suspect diversifying across multiple regions but staying in equities is probably not going to have much of an impact on your long-term returns.
Equity Risk is Equity Risk. You are probably better off just owning a single US Small Cap ETF and calling it a day.
I also fail to see the advantage of owning bonds at all in retirement accounts if you are younger than 50 or so.
posted by JPD at 12:08 PM on August 14, 2013 [1 favorite]
Equity Risk is Equity Risk. You are probably better off just owning a single US Small Cap ETF and calling it a day.
I also fail to see the advantage of owning bonds at all in retirement accounts if you are younger than 50 or so.
posted by JPD at 12:08 PM on August 14, 2013 [1 favorite]
Also the math is pretty clear. The best way to hedge equity risk is to own cash. Owning long-term government bonds adds new risk to the portfolio in the form of duration, and a bond fund that isn't just sovereigns adds credit risk, and credit risk is pretty correlated with equity risk.
posted by JPD at 12:09 PM on August 14, 2013
posted by JPD at 12:09 PM on August 14, 2013
"The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply."
Quote by Warren Buffet that might help if you plan to put more money in the market over the next 10 years.
posted by laukf at 1:43 PM on August 14, 2013 [1 favorite]
Quote by Warren Buffet that might help if you plan to put more money in the market over the next 10 years.
posted by laukf at 1:43 PM on August 14, 2013 [1 favorite]
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If you don't need the money for ten years or more, don't worry about hedging. Its never worth the cost.
posted by JPD at 7:50 AM on August 14, 2013 [2 favorites]