March topped a volatile and challenging quarter for investors, with losses of 4.9% for the S&P 500, 4.6% for the Dow Jones Industrial Average, and 9.1% for the NASDAQ. Not even bonds were spared, with US Treasurys down 5.6% in the face of the first increase in interest rates by the Federal Reserve since 2018.
March alone gave investors plenty to worry about: the on-again, off-again cease-fire talks between Russia and Ukraine; record-high gas prices (they’re more than $6 a gallon here in California, where I live); rising prices for everything from rent to groceries and everyday household goods; and 30-year fixed mortgage rates rising to 4.67%, the highest since 2008 — just to name a few.
In contrast, commodities — like oil, copper, and wheat — had one of their best quarters in decades, driven primarily by two things: disruptions in the supplies of wheat, corn, and barley stemming from the invasion of Ukraine, and US and Western allies’ sanctions on Russian oil. President Biden and other Western nations recently agreed to release oil reserves in an effort to tamp down rising oil prices.
The question on everyone’s minds: Are we heading for a recession?
As if rising inflation weren’t enough to keep investors nervous, just last week, the US Treasury yield curve inverted. Specifically, the yield on US Treasurys that mature in two years exceeded that of Treasurys maturing in ten years. Normally, the longer a Treasury’s maturity, the higher the yield, as investors expect higher compensation for holding the bonds over longer periods. So when the curve inverts, it’s a sign that things are a bit out of whack. An inversion has often preceded a recession in the past, so many people consider it to be a recession warning. But it hasn’t always, which muddies its use as a true crystal ball.
Positioning your portfolio and enhancing returns
As we’ve discussed time and time again (perhaps ad nauseum!), uncertainty and volatility are unavoidable when it comes to investing. While the events of March might feel worrisome, overhauling your portfolio in response isn’t the answer. Instead, proper diversification and a long-term view for your long-term financial goals come together to form the foundation of investing success. If your portfolio is properly positioned for the long term, it should be able to ride out the market’s ups and downs.
But while we can’t control markets, world events, or gas prices, we can help enhance portfolio returns by being intentional about (pause, for dramatic effect) taxes. It’s true. Being mindful of how taxes impact investment returns is one part of investing that you can control.
At Ellevest, we work with our clients to manage ongoing tax consequences by using tax-minimization techniques like tax loss harvesting, using cash flows strategically when rebalancing, minimizing short-term gains when trading, and timing the sales of securities and the exercise of stock options to minimize tax liabilities where possible.
Also, for each investment we include in our clients’ portfolios, we carefully consider its tax efficiency and after-tax expected returns, as well as its best placement across taxable and tax-advantaged accounts (commonly known as asset location). Some asset classes are more “tax-efficient,” which means any distributions will be taxed at the most favorable tax rates. In contrast, “tax-inefficient” investments, like corporate bonds, distribute income that would be taxed at a (typically higher) ordinary tax rate. It’s usually better to place tax-inefficient investments in tax-deferred accounts like individual retirement accounts (IRAs), since the taxes won’t be paid until later, once you retire.
Another potentially tax-smart move could be to add municipal bonds to your portfolio. They remain one of the few asset classes that are exempt from federal (and, in some cases, state) taxes. Plus, while bond yields are still historically low, they’re expected to rise. If President Biden’s proposed tax rate increases come to pass, municipal bonds could become a suitable investment for earning higher tax-equivalent yields. Tax-exempt income is also excluded when calculating your gross income.
Each investor’s financial situation and tax posture is unique, so be sure to speak with your financial, tax, and estate professionals to understand what strategies might be right for you. As markets continue to chart new territory, focusing on those elements of investing that you can control — like reducing risk through proper diversification and close attention to taxes and fees — can help your portfolio regardless of what course the markets take.
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