This Is Why Sound Principles Matter

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Last month, I discussed a set of principles that form the foundation of the Equius approach to investing. Following these principles is always important, in our view, but particularly today as market volatility and uncertainty have increased.

The recent market decline

The big news recently, of course, is the severe market slide that started in mid-February. After closing at a new high of 29,551 on February 12, the market (DJIA) fell off a cliff and finished at 25,409 on February 28—a 14% decline over 11 trading days.

This follows a 451% rise in the market from March 2009 to January of this year, so the decline is certainly within expectations. Nevertheless, it’s painful, particularly for investors who have not enjoyed rising stock prices over the past 11 years. And this decline has a panic feel to it, driven, some say, by economic concerns related to the outbreak of the coronavirus.

What investors should keep in mind is that the market could turn around just as quickly on other news, such as an effective coronavirus treatment or vaccine. Or the market decline could be slowed by news that the mortality rate is lower than first thought. We’re also headed into warmer weather and higher humidity as we approach springtime in the US, which might slow the spread of viruses.

We don’t know how far prices could drop or for how long. This is why discipline, focus, a long view, and simplicity in executing our strategy remain critical to the success of our approach.

Rebalancing challenges

Equius has implemented a rebalancing discipline on client portfolios since our founding. In the risk-based structure that defines our asset class strategy, it’s important to maintain portfolio risk at predetermined levels. This discipline leads to greater certainty about a long-term expected return (since risk and return are directly related in an efficient market).

This risk/return match is what we strive to optimize and maintain for clients based on their unique circumstances. Thus, when an asset class exceeds its policy allocation by 20%, the excess needs to be sold and reinvested in asset classes below their policy allocations. When an asset class drops below its allocation by 20%, we buy more by selling a portion of one or more of the other asset classes that are above their allocations. Most often, this is done as a result of scheduled portfolio cash flows in and out.

In late 2008 and early 2009, stock prices tumbled as the effects of a collapse in real estate prices turned into a global financial crisis. Panicked investors couldn’t dump stocks fast enough. In contrast, we were selling a percentage of our clients’ bond allocations to buy stocks as they fell in price in order to bring overall allocations back in line with long-term objectives.

It wasn’t easy, either emotionally or mechanically, as we received pushback from some clients. But we were rewarded in early March 2009, when stock prices exploded upward at the beginning of what has been an 11-year up market.

Just as buying during market declines is difficult for most investors, selling—even for rebalancing purposes—is often just as difficult.

In taxable portfolios, rebalancing after stock prices have risen generally results in a capital gain tax. We manage these gains as much as possible (long-term versus short-term gain, offset with harvested losses, etc.), but they’re inevitable. In some cases, we might encounter pushback from a client who simply does not want to realize the gain and pay the tax.

We call this behavior “allowing the tax tail to wag the investment dog.” Our response is that you either make up your mind to follow the discipline, pay the tax, and celebrate the win, or—especially after more than a decade of rising stock prices—the market “takes care of” some or all of the gain for you.

This current environment challenges us all to remember why we have chosen this particular strategy to create, grow, and maintain wealth. Our intention is to reduce anxiety, not add to it, so please don’t hesitate to call us if you have questions or concerns.

We’re also happy to “spread the love” of asset class investing, so please feel free to send others our way if you believe they could benefit from our services.

Thank you.

Equius Partners, Inc. is a Registered Investment Advisor.

Past performance is not a guarantee of future results. The data and information set forth herein are provided for educational purposes only and should not be considered tax, legal or investment advice; a solicitation to buy or sell securities; or an opinion on specific situations – as individual circumstances vary. There is no guarantee an investing strategy will be successful. Investing involves risks, including possible loss of principal. Diversification does not eliminate risk, including the risk of market or systemic loss.

Please consider the investment objectives, risks, and charges and expenses of any mutual fund and read the prospectus carefully before investing. Indexes are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

© 2023 Equius Partners, Inc.

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