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Client File: The Usual Suspects

usual suspectsNo, we are not talking about the hit movie from 1996 (written by local writer Christopher McQuarrie). We are talking about when we work with clients who come to us with the same set of 15-20 stocks, which internally we call “the usual suspects.” Typically these stocks were either inherited or they were purchased decades ago. Since they have been held for so long, selling any of the shares would result in a large tax bill.

These stocks are usually held because they are “good companies” or because there is a sentimental value attached to them. However, over the past few years, these stocks may have underperformed the overall market and now there is uncertainty on what to do going forward. They are also reluctant to sell them because they do not want to pay taxes. Inaction is what usually happens and this is not always the best outcome.

We bring this up now in light of recent stock market volatility*. A drop in the stock market should not be viewed with fear, but instead as an opportunity to either rebalance or to add additional diversification to your portfolio for a lower (or no) tax bill.

Our approach to investing is summarized into three principles; strategy, process, and managing behavior. For those who choose to concentrate their investments into just a few stocks their strategy is to increase their risk by investing in just a few stocks in hopes for a high return. Their process is to hold the stocks and do nothing, and their behavior is to invest in what is familiar. This usually results in a lack of diversification and a misalignment with risk tolerance and financial goals.

Our perspective is to use any drops in the stock market as opportunity to further diversify a concentrated investment portfolio. Our actions in 2008 are a good example. There were several clients who had concentrated stock positions, but their allocation to stocks were too large because they didn’t want to sell and pay capital gains taxes. As a result, they lost much more in the stock market drop that year than they would have if they just paid taxes and diversified.

Our strategy was to develop a target allocation of stock and bonds consistent with their risk tolerance and goals. Then we followed a process to gradually diversify their portfolio using several different tax management strategies. Going forward, managing behavior is key, especially as it relates to individual stock holdings. Many people exhibit familiarity bias when it comes to investing. They become familiar with an investment and therefore it appears to be less risk. We help our clients manage these behavior biases and make decisions without emotion getting in the way.

Ultimately, the structure of your investments determines its performance. There are five decisions to be made when developing an investment strategy and this determines how much money you will earn and how big the ups and downs will be from year to year.

  • How much do you have in stocks and bonds?
  • Are your stocks large or small companies?
  • Are your stocks low priced value stocks or higher priced growth stocks?
  • Are your bonds short or long in term?
  • Are your bonds high quality or low quality?

We help our clients determine the answers to these questions and then implement solutions to help them achieve the highest probability of success for realizing their goals.

 

*referring to September 2015 volatiltiy in the market

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