Repositioning your portfolio for recovery

William F. (Ted) Truscott, Chief Investment Officer

It's no surprise that people are looking for ways to help their investment portfolios recover after significant deterioration in the markets. Here are a few considerations you should discuss with your financial advisor that draw on some of the lessons I've learned about portfolio management in this type of environment.

• Treat every day of your investment portfolio as if you bought the entire portfolio at today's prices. While we discourage short-term thinking, this exercise is useful because it makes you ask yourself if you're happy with each investment. Is the original premise for purchasing the investment still intact?

  It also causes you to think about a seeming paradox in investing. Suppose you bought a stock or a stock fund filled with high-quality companies that fell from $10 a share to $5. If the long-term prospects of the company (or fund that represents multiple companies) remain intact, it would be unwise to sell at a 50% discount. In fact, you may even consider buying more. This is where the concept of "staying the course" originates – essentially, accepting a loss and realizing that new purchases at $5 may lead to greater opportunities in the future.

• Take advantage of dollar-cost averaging.¹ This investment strategy can help you take advantage of the market highs and lows. By investing a fixed dollar amount in a security (e.g., mutual fund, stock) at regular intervals, you may be able to reduce your average price per share while consistently building your portfolio.

  Say you have $100 that you invest in a stock every month through dollar-cost averaging. In 2008, maybe you were getting 4 shares a month at $25 each from January through April, adding up to 16 shares. From May to August, your price per share went down to $16.50 per share, so you were able to purchase 24 shares. And from September through December, your share price dropped to $14, allowing you to buy another 28 shares. By consistently purchasing shares throughout the year, you would have built a portfolio of 68 shares by year end. If and when the share price goes up again, you should have more to show for your longer-term strategy than someone who invests a lump sum at the beginning of the year.

• Think about whether you should sell part of your equity portfolio. As investors, we all have different time horizons and tolerance for risk. Those with shorter time horizons may not have the luxury of engaging in the exercise above. Thus, you may decide to sell part – not all – of your equity portfolio and reposition into bonds or bond funds, fixed annuities, CDs or certificates that offer a fixed rate of return. Your financial and tax advisors can help you determine the best solution based on your situation.

• Consider selling some of your stocks at a loss to gain a tax benefit. If you have stocks in a non-qualified account and you sell them at a loss, you may be able to reduce your tax burden. This is a painful decision, but it should be discussed and considered carefully.

  I have, in consultation with my financial and tax advisors, sold some stocks and stock funds at a loss and bought bonds and bond funds. I remain predominantly invested in equities as I have a long time horizon, but I can take advantage of the tax loss. I also believe that repositioning my portfolio somewhat more toward bonds offers a chance for quicker recovery. Everyone's situation is different, but I would argue that now more than ever these types of tough decisions need to be made.

  Realized capital losses can offset realized capital gains and up to $3,000 of ordinary income each year. Unused capital losses carry forward indefinitely.

• Evaluate other unique strategies. There may be special situations when you need to consider a different strategy. Let's say an investor was planning to leave money for her children and that inheritance has fallen by 50%. She may consider purchasing life insurance for the portion of the inheritance that was lost. This can eliminate or reduce the uncertainty that the portfolio will recover its lost value and, ultimately, provide her children with the intended inheritance.

These examples show the types of decisions investors face today. But they also illustrate how we as investors can take control of our destinies – even when everything around us seems out of control.

Consult your financial advisor to determine if these or other strategies could help you reposition your portfolio for recovery.