Tax Loss Harvesting: How to Make the Most Out of Market Volatility

When we invest money, our main objective is to see the money grow. When we think about market losses and downturns, we may think of painful periods where we watch our account balances decrease instead of grow. While market losses are never fun, they are unfortunately a part of the normal investment life cycle. However, when market volatility hands us losses, there are some options to make lemonade out of lemons.  

What is tax loss harvesting?

Tax loss harvesting is the process of selling securities while they are at a loss, realizing that loss for tax purposes, and then redeploying that money into another investment (such as a different stock, bond, or mutual fund). The IRS does not allow you to sell an investment at a loss, receive the tax benefit, and then immediately reinvest those proceeds into the exact same security right away. Selling a security and re-purchasing it within the same 30-day window is called a “Wash Sale.” You can avoid triggering the Wash Sale rule by investing in something similar but different enough to avoid having the rule apply.

While most people will tend to do this only once at year end, this is actually something that can be done at any time in the year with no limit as to how frequently you do so. With custom indexing and commission-free trading, frequent tax loss harvesting has become more achievable than ever. In years of high volatility, frequently harvesting tax losses can have a big impact on your tax bill.  

Keep in mind that for this strategy to work, you must have capital invested in a taxable, non-retirement brokerage account. Your 401(k) and IRA are not eligible for tax loss harvesting.

How does it benefit you?

In years of extreme volatility, you may be able to accumulate a large amount of tax losses in a short period of time. These losses can then be used to offset future capital gains.  If you end up with more tax losses than you have gains to offset them in any given year, you can use the losses to offset up to $3,000 of ordinary income on your tax return.  

You will be able to carry forward an unlimited amount of these losses into future tax years until you’ve been able to use them up.

Tax loss harvesting can be especially useful for investors who might have highly concentrated company stock with a large amount of unrealized gains, or other legacy investments that they’ve been holding onto to avoid a large tax impact. These tax losses can be used to help decrease single stock risk and sell off legacy assets with little to no tax impact.

What are the next steps?

If you are a Warren Street client, we are already doing this for you (as applicable).  For clients with larger taxable brokerage accounts invested in our custom indexing strategy, you will likely see tax loss harvesting happening on a more frequent basis.  

All in all, seeing losses reported on your Form 1099 form is not necessarily a bad thing. While your long term objective remains the same in terms of seeking growth, taking advantage of short term volatility through tax loss harvesting can lead to a nice tax perk that can aid in your overall financial return on investments in the long run.

If you have any questions or would like to speak with one of our advisors for complimentary portfolio review, you can schedule a consultation here

Justin Rucci

Justin D. Rucci, CFP®

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Actions to Take in a Market Downturn

Market downturns are an expected part of investing, but they can be painful and nerve-racking nonetheless. Investors often want to take action or make changes during these times. Predicting which way the market will move in the short term is nearly impossible; short-term changes usually work against us. Below you will find some actions that you can take during a market pullback that will often yield positive results.  

Here are some potential actions to take during a market downturn:  

  • Continue to invest. Market downturns may provide an opportunity to buy into the market at a lower entry point. Consider increasing your savings and investing rate during this time.  
  • Tax loss harvesting. Loss harvesting is a way to turn lemons into lemonade. Loss harvesting allows investors to take advantage of their portfolio losses by realizing the losses and using them to reduce taxable income.  
  • Hold off on large withdrawals. Wait until the market recovers to make larger-than-usual portfolio withdrawals.  
  • Overall financial planning check-up. Now is a good time to take care of any financial planning items that have been lingering on your to-do list. Check your beneficiaries, review your estate documents, and review your insurance coverage. The market is not in your control, so take a minute to review and manage anything that is in your control.  
  • Check your 401(k) allocation and contributions. Make sure you are on track to receive any company matching contributions.  
  • Roth conversions. Roth conversions are case-by-case specific, but generally speaking periods of market volatility may create opportunities for Roth conversions. The idea is to convert funds from a Regular to a Roth IRA while your account value is low, decreasing the amount of tax generated from the conversion. Assuming the market eventually recovers, your newly converted Roth dollars will appreciate tax free (assuming you meet all the other criteria necessary for Roth tax treatment). This scenario works best when you are in a low tax bracket and have the cash to pay tax on the conversion.
  • Rebalance your portfolio. Rebalancing your portfolio often forces you to sell high and buy low, even during periods of market downturn. By rebalancing during volatility, you are selling the funds that have held up better (typically bonds and other diversifiers), and reinvesting into the areas that have pulled back. This forces you to “buy the dip.” If/when the weaker parts of your portfolio recover, you participate more fully.  
  • Reevaluate your risk level. Market corrections provide an opportunity to increase your risk level (i.e., your stock exposure) and to take advantage of lower stock prices.  Typically these periods are not a good time to lower risk by selling stocks unless your goals and/or investment time horizon has changed.  

Usually the best action is no action. If you’re not in a position to save more, sticking to your long-term allocation and plan is likely the best way to weather market turbulence. Market corrections will continue to happen over the course of your investing life. While overall the long term trend tends to be upward, corrections will typically happen every few years.  During turbulent times, emotional decision-making often works against us.

The chart below illustrates how the S&P 500 has performed after a variety of global events and conflicts since 1950.  You can see that in most cases, the market has had strong performance in the years following a crisis.  

Please feel free to reach out to us if you have any questions. If you would like to speak with one of our advisors for complimentary portfolio review, you can schedule a consultation here

Emily Balmages, CFP®, CRTP

Director of Financial Planning, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Series I Bonds: Are They Right For You?

Series I bonds offer a low-risk, interest-earning addition to your portfolio. As part of a well-diversified portfolio strategy, now may be a good time to put some additional cash into I bonds and take advantage of an attractive interest rate.

What is a Series I bond?

A Series I bond is issued by the US Treasury. The bond accrues interest monthly until it reaches 30 years or you cash it, whichever comes first.

An I bond has two interest rates – the fixed rate and the inflation rate. These two rates combine to determine a bond owner’s actual rate of return, called the composite rate. A new rate will be set every six months based on the fixed rate and on inflation.

The US Treasury limits the composite rate to no less than 0%, meaning the rate of return on I bonds will never be negative.

What’s the benefit?

The composite rate on Series I bonds is currently 9.62% (annualized). Though the interest rate is variable and will change over time, purchasing I bonds now guarantees that you will earn this interest rate until October 2022 when the new rate is set for the next 6 months.

Are there risks?

An I bond is considered an extremely low risk investment. However, the ultimate rate of return is variable and not guaranteed beyond the current 6-month rate. The current interest rate is high because inflation is higher than usual – if Federal Reserve policy reduces inflation the inflation rate for I bonds will also decrease.

Note that an I bond cannot be redeemed for at least one year after purchase, and any redemption between years 1 and 3 does not receive the interest from the three months prior to redemption.

How do I buy a Series I bond?

Visit treasurydirect.gov to purchase electronic I bonds. An I bond must be purchased directly by the investor; it is not something your advisor can add to your portfolio for you. Series I bonds purchased electronically come in any amount to the penny for $25 or more. Paper I bonds can be purchased using your federal income tax refund. The amount of a bond purchased is limited to $10,000 per person per year.

Are I bonds right for me?

Determining what investments are the best fit for you depends on several factors: your age, the timeline for when you need to withdraw from investments, your comfort with risk, and your overall financial health. If you have some cash that is not part of your basic emergency fund and you do not need it in the next 1-3 years, I bonds may be a good choice. However, as with all investing decisions, we recommend consulting with your financial advisor to determine if I bonds are the best fit for your unique situation.

Kirsten C. Cadden, CFP®

Associate Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Part 3: A Lookback at Q1 and Portfolio Impact

If you’re talking with friends about market volatility, pessimists may say “downward is the only way forward,” but optimists like us will continue to share the sentiment that “We Will Prevail,” which is based on our assessment of history, data, and our go-forward market outlook.

For those of you who caught that subtle reference from the movie Inception, maybe you’re getting a taste for how big of a cinephile I am. For those who didn’t – no sweat; let’s wrap up this series of blog releases by assessing the first quarter’s market performance. 

Before diving in, it’s important to note the macroeconomic trends that are primarily driving market risk: 1) the tightening of financial conditions and 2) the war in Eastern Europe. The Federal Reserve and other Central Banks are raising interest rates to calm inflation. Meanwhile, Russia’s invasion of Ukraine has had knock-on effects economically, particularly in Europe. With that in mind, see below for how markets are ending the first quarter.

Exhibit A – Asset Class Performance in 2022

Source: YCharts

The Laggards

Looking at Exhibit A, bonds, followed by US Large Growth names (i.e., AMZN, AAPL), and international stocks (i.e., emerging markets and Europe stocks) are lagging. 

  • Bonds Begrudgingly Behind: recent bond volatility can be attributed to inflation and rising interest rates. Inflation diminishes the purchasing power of a bond’s interest payments, while interest rate hikes apply downward price pressure on the value of a bond (you can now find a similar bond in the market yielding a higher rate). 
  • Growth Names Falter: This asset class includes larger companies that are typically more expensive (e.g., Amazon, Apple), with stock prices that are highly dependent on future earnings growth. However, rising interest rates are raising the cost of borrowing, which depletes the value of a company’s future cash flows and are skewing growth names to the downside.

Exhibit B – How Are Big Tech Stocks Doing?

  • International Stocks Give Up Ground: At the start of the year, international stocks including European, Australian, and Far East (EAFE) and Emerging Markets (e.g., China, Brazil) equities outperformed domestic markets. US markets were being punished for an overweight to growthier names amid interest rate hikes. Most recently, the Russian invasion of Ukraine has dampened investor appetite for the international scene, overturning the region’s initial outperformance. 

Exhibit C – The Race Between International and the US

Source: YCharts

Leaders

  • Gold Shines Bright: After a lackluster 2021, gold regained its shine this past quarter. Geopolitical uncertainty, coupled with a distrust of central banks to tame inflation, has resulted in sizable outperformance from the precious metal.
  • Value Names Triumph: While US Large Growth suffers from tighter financial conditions, investors are paying more attention to company profitability. US Large Value typically consists of companies that are larger, have a long-standing business model, and proven profitability. Examples include Target, Walmart, and Disney. 
  • S&P 500 Recovers: After a weak start to the year (at one point being down 12% year-to-date), the S&P 500 has largely regained lost ground. Although the expectation of rate hikes remains a risk to the broader index, domestic markets have been favorable given a relatively unthreatening economic impact from the Eastern European war.

Takeaways, Portfolio Impact and Our Game Plan

Takeaways – Is the 60/40 Portfolio Dead? A 60/40 portfolio has long been coveted as the standard for a “moderate” risk investor, with a 60% allocation to stocks and a 40% allocation to bonds. The bond allocation is meant to mitigate volatility during downturns, but with today’s largely challenged bond environment, the asset class has not cushioned investors during this recent equity sell-off. 

Source: YCharts

Exhibit C includes the annual returns of a 60/40 portfolio, the global stock index (Ticker: ACWI), and the passive bond index (Ticker: AGG). Over the years, bonds have served as a protector against equity volatility, capturing a fraction of an equity market drawdown. However, thus far in 2022, bonds are selling off more than equities. Therefore, investors should not expect to receive similar risk-adjusted returns they did in the past for a traditional 60/40 portfolio – at least in the near term.  

Portfolio Impact – Thinking Outside the Box: With the 60/40 structure in jeopardy and bonds to endure some short-term pain, a different approach should be considered. Enter Warren Street’s Real Assets sleeve – or what we like to call “Diversifiers” – which consist of real assets that typically benefit from inflation (i.e., gold, natural resources, and real estate).

Last summer, after acknowledging the adverse circumstances of the bond realm, Warren Street proceeded to underweight bonds and overweight diversifiers within blended models on top of initiating a position in a commodities fund. This trade has rewarded our portfolios and cushioned the bond and equity sleeves amid the most recent 2022 sell-off.

Our Game Plan – An International Resurgence: With Diversifiers outpacing stocks, our team rebalanced real assets into equity weakness, effectively selling high and buying low. We will continue to monitor momentum within Diversifiers and the bond landscape before returning to our neutral weights. 

The looming question remains on our equity strategy, which incurred relative underperformance attributed to our overseas exposures. Although Russia’s military invasion overturned initial outperformance against domestic markets (see Exhibit C), we believe there is significant headroom for an international equity resurgence should the war abate. 

Albeit still unpredictable, Ukrainian resistance is increasing the probability for a ceasefire. Couple that with the pandemic transitioning to an endemic, a US market that is more sensitive to central bank reserve tightening and attractive valuations overseas, we continue to remain optimistic about our clients being rewarded for their patience and for avoiding home-country bias. 

Conclusion

You’ll hear us say it time and time again: control what you can control. Throughout this quarter, our team has tax-loss harvested in accounts amid sell-offs, rebalanced diversifiers into equity weakness, and thoroughly assessed the impact of conditions #1 and #2 mentioned above in our portfolios.

Outside of portfolio strategy, we’ve made strides in uploading more content on socials, blogs, and video formats to upkeep communications beyond our client meetings. We encourage you to read recent blog releases pertaining to the war in Ukraine and to give us a follow on social media. 

Ultimately, the movie inception is about planting an idea and allowing it to grow. I’m no extractor or architect of dreams, but let me attempt to fortify my parting idea once more: “We Will Prevail.”

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Part 2: Assessing War and the State of the Global Economy

Don’t Miss the Big Picture 

With news outlets centered on Eastern Europe, it is easy to miss the bigger economic picture both globally and domestically. For a broader assessment, it helps to understand how Russia fits into the global economy. Prior to the invasion, the Kremlin represented just 3.11% of global GDP.  

To further illustrate, Exhibit A and Exhibit B portray the size of Russia’s economy, population, and percent makeup of the global stock market compared to other countries. Looking at Exhibit A, Russia has the largest population of this subset, yet its economy (the size of the bubble) is smaller than Texas. Thus, the war’s direct effect on global growth was already limited even before indices deemed Russia as “uninvestable” or before western parties imposed sanctions.  

Exhibit A – Russia’s Economy is Smaller Than Texas 

Exhibit B – Russia is Miniscule compared to the US, China, and India  

Zooming out in Exhibit B, you can assess just how small Russia is relative to the United States and its Asian neighbors China and India.  

The State of the West 

Before discussing other nations, let’s cover our home turf. Within the United States, we have successfully fended off the Omicron wave. COVID-19 data is trending in the right direction, pandemic related pressures (i.e., labor market, car prices) are slowly easing (Exhibit C), and consumer balance sheets are rock-solid (Exhibit D).  

Exhibit C: The Labor Market is Loosening, and Inventories are Building 

Exhibit D.1: Debt as a % of Consumer Incomes

Exhibit D.2: Consumers Have a Record $2.4T in “Excess Savings”

Although the threats of additional COVID-19 variants and prolonged inflation linger, our economy is expected to produce above-trend economic growth (see Exhibit E). In fact, economists remain optimistic about the US economy, with the median 2022 real gross domestic product forecast only revised 0.10% downwards after the invasion of Ukraine.  

Other major economies (particularly in Europe) are more at risk for an economic slowdown attributed to higher energy prices (i.e., over $120/barrel for Brent Crude driven), or what we call “pain at the pump.”  

Although Europe derives 40%+ of its natural gas from Russia and Ukraine, we expect that new measures targeting energy independence and militaristic efforts will have positive long-standing effects on European growth despite interim road bumps. For some near-term perspective, European nations are still expected to grow GDP above their long-term forecasts in 2022 (see Exhibit E).

Exhibit E: How Much Are Our Economies Expected to Grow in 2022?

Commodity Chaos – Not to be Overlooked 

Although the war’s direct effect on global growth is likely to be meager, indirect pressures on commodity prices are a larger concern, as they may diminish the purchasing power of disposable incomes. Russia is the world’s second largest oil producer behind the US, and accounts for 12% of global production. Also, Russia and Ukraine make up 25% of global wheat exports, 33% of global corn trade, and 80% of sunflower oil production.  

What happens if sanctions are imposed, or if nations surrender agricultural practices to fight on the battlefield? The price of electricity in your factories will rise. Middle eastern nations reliant on wheat imports (i.e., Egypt and Lebanon) must ration appropriately. Chinese-grown hogs – which feed on corn – are more expensive to raise. Lastly, the price of that bag of Ruffles (made from sunflower oil) is expected to increase. 

Exhibit F: Commodity Prices Are Rising

Where Do We Go from Here? 

Could this lead to inflation? Yes – we have already seen commodity prices surge exponentially. Does this mean that the US economy will fall to its knees? The probability of that is very low.  

After all, two-thirds of our nation’s economy is consumption-driven, and with consumers looking healthy and a central bank easing the economy into a higher rate environment, it is hard to envision a full-scale economic disaster unfolding. Even if we run into a recession, perhaps it will be much smaller than our recent lived experiences of the Great Recession and the Great Lockdown (2020 COVID-19 Pandemic).  

Our European neighbors will be more vulnerable over the next three months, especially with an energy embargo on Russia still on the table. However, between German Chancellor Olaf Scholz mobilizing its military (for the first time in 20 years), renewed sentiment on energy independence, and a newfound unity amongst the entire West, the European economy is exuberating a different luster and willingness to grow than it did in previous years. Should this war abate, we believe Europe could resume course towards full recovery and investors with allocations will be rewarded. 

A Stronger West, Once the War is Put to Rest 

Ultimately, our sentiment from part 1 of this series that “We Will Prevail” has not changed. We have endured many instances of short-term pain and come out victorious. This time is no different. I am confident that our economies – particularly the West — will emerge stronger and more united after this war is put to rest.  

Stay tuned in part 3 where we discuss asset class performance and portfolio impact! 

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Part 1: We Will Prevail

“There are decades where nothing happens; and there are weeks where decades happen.”

– Vladimir Lenin

The words of Lenin, who led the Russian Revolution in 1917, are ringing true in his own country over 100 years later. Russian Prime Minister Vladimir Putin’s decision to invade Ukraine took the world, and financial markets, by storm. For investors, initial instincts may prompt feelings of worry, and rightfully so.

After all, homes are collapsing, buildings are burning, and civilians are being displaced in what publications are calling the biggest war in Europe since 1945. First and foremost, we empathize with the human concerns and humanitarian disaster resulting from Russia’s full-scale invasion of Ukraine. We believe that a broad understanding of the market’s relationship with geopolitical crises, the state of the global economy, and the war’s impact on broad asset classes will help investors navigate this turbulent time.

This series will aim to address the concerns that arise for investors and global markets during such times.

Weathering the Storm

In an era where G20 nations are accustomed to diplomacy, the impact of war on markets may seem foreign. However, we can turn to history to help distinguish relationships between capital returns and warfare. Below is a chart showing the growth of $10,000 invested in the S&P 500 since 1950, overlayed with a myriad of events.

Exhibit A1

Looking back, the S&P 500 grappled with numerous instances of geopolitical turmoil, nationwide systemic meltdowns, and a global pandemic. Despite these vulnerabilities, notice the trend and direction of that initial $10k: it consistently recovers and grows over time Furthermore, Exhibit B features returns 12, 24, and 36 months after the market bottomed in each war.

Exhibit B 

These charts convey two things:

  1.  Despite volatile periods, investors have generally been rewarded for putting their capital at risk.
  2.  Human beings are incredibly resilient. We’ve lived through arduous events, gritted our teeth, and made it to the other side.

Some people are comparing this conflict to World War II, but we disagree given that the battle is regionally contained and the US is unlikely to become directly involved. The conflict can, and likely will, get worse. But the probability of another world war is low.  

The outcome of Russia’s invasion is difficult to predict. Whether Putin succeeds in establishing a puppet government in Kyiv or a ceasefire is negotiated, we have faith that humankind will persevere and that capital will continue to seek the most efficient allocators, leading to long-term positive returns. In other words, we will prevail.

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Footnotes & Sources:

  1. Chart is not log-scaled and thus understates market return volatility.

What Is Custom Indexing, and Is It Right for Me?

If you’ve ever felt that mutual funds and ETFs don’t give you enough control over the individual stocks you want to invest in — or don’t want to invest in — you’re not alone.

Clients over the years have shared with us that they want to own individual stocks. However, one of the hidden benefits of owning individual stocks are the after-tax returns generated through tax-loss harvesting. You may ask, “why are we hearing about this now?” Well, the reality is the technology did not exist.

The Freedom of Custom Indexing

We have good news: with the addition of Warren Street’s new custom indexing platform, you now have the ability to “custom index” — in other words, set the parameters on the exact types of stocks you’d like to invest your money.

Unlike ETFs and mutual funds that only offer pre-packaged asset mixes, custom indexing lets you personalize your investments to your individual values, preferences, and goals. Custom indexes are implemented through separately managed accounts (SMA), which allow you to directly own a mix of individual securities rather than indirectly owning positions through shares of funds and ETFs.

This can be an especially helpful option for individuals who may want to:

  • Reduce concentrated stock risk (e.g., employer stock)
  • Custom-build a portfolio to support ESG stocks
  • Offset embedded gains with cash or tradable securities
  • Invest in an individual stock portfolio with factor tilt

If custom indexing is a good fit for you, your advisor will discuss your goals, preferences, risk tolerance, and tax positioning. Then, he or she will help you design your custom portfolio from scratch, based on considerations such as asset allocation, factors, tax-loss harvesting, and values-based screens.

Ideal Clients for Custom Indexing

While custom indexing offers you some great advantages in selecting individual stocks, it only really benefits clients that meet certain account levels and qualifications, due to tax and expense considerations.

Ideal clients for custom indexing generally include those with:

  • At least $500,000 in a taxable, non-retirement account
  • Recurring cash contributions
  • A high-income tax bracket (Fed/State)
  • Preferred individual stock exposure over funds

Through direct indexing, custom indexing can replicate broad market exposure by investing in the underlying positions of an index fund or ETF. This helps us efficiently manage your taxes (if you meet the above qualifications) and gives you virtually infinite portfolio customization capabilities.

Interested in learning more? For a full deep-dive into our custom indexing platform, check out the attachment linked below. And feel free to reach out to your lead advisor if you think you might be a good fit!

Blake Street, CFA, CFP®

Founding Partner and Chief Investment Officer, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Fighter Planes and Market Turmoil

Have you been reading the daily headlines—watching markets stall, recover, and dip once again? If so, you may be wondering whether there’s anything you can do to avoid the motion sickness. 

If you already have a well-structured, globally diversified portfolio tailored for your goals and risk tolerances, our answer remains the same as ever: Your best course is to stay the course. Remember, our investment advice is aimed at helping you successfully complete your long-term financial journey. As “The Psychology of Money” author Morgan Housel has observed:  

“Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another.”

The Case of the Missing Bullet Holes

Have we ever told you the tale of the World War II fighter jets and their “missing” bullet holes? Today’s bumpy market ride seems like a good time to revisit this interesting anecdote about survivorship bias. 

The story stems from studies conducted during World War II on how to best fortify U.S. bomber planes against enemy fire. Initially, analysts focused on where the returning bombers’ hulls had sustained the most damage, assuming these were the areas requiring extra protection. Fortunately, before the planes were overhauled accordingly, statistician Abraham Wald improved on the evidence. He suggested, because the meticulously examined planes were the survivors, the extra fortification should be applied where they had fewer, not more bullet holes. 

How so? Wald explained, the surviving planes’ bullet-free zones were not somehow impervious to attack. Rather, when those zones were getting hit, those planes weren’t making it back at all. Survivorship bias had blinded earlier analyses to the defenses that mattered the most. 

Surviving Market Turbulence

You can think about the markets in similar fashion. For example, consider these recent predictions from a well-known market forecaster (emphasis ours): 

“Jeremy Grantham, the famed investor who for decades has been calling market bubbles, said the historic collapse in stocks he predicted a year ago is underway and even intervention by the Federal Reserve can’t prevent an eventual plunge of almost 50%.” 

ThinkAdvisor, January 20, 2022

At a glance, that sounds pretty grim. But read between the lines for a hidden insight: He was also predicting the same collapse a year ago??? Yes, he was: 

“Renowned investor Jeremy Grantham, who correctly predicted the Japanese asset price bubble in 1989, the dot-com bubble in 2000 and the housing crisis in 2008, is ‘doubling down’ on his latest market bubble call.” 

ThinkAdvisor, January 5, 2021

What if you had heeded Grantham’s forecasts a year ago, and left the market in January 2021? Time has informed us, you would have missed out on some of the strongest annual returns the U.S. stock market has delivered in some time. 

Now What?

If market volatility continues or worsens, brace yourself. You’re going to be bombarded with similar predictions. Few will be bold enough to foretell the exact timing, but the implications will be: (1) it’s going to happen soon, and (2) you should try to get out before it’s too late. 

Some of these forecasts may even end up being correct. Bear markets happen, so anyone who regularly forecasts their imminent arrival will occasionally get it right. Like a stopped clock. Or those continually looping infomercials on how “now” is the best time to load up on silver or gold. (Incidentally, many of these same precious metal purveyors are among those routinely predicting the end is near for efficient markets.)  

Bouts of market volatility are like the bullet holes we can see. They’re not pretty or fun. But interim volatility isn’t usually your biggest threat … attempting to avoid it is. The preparations we’ve already made may be less obvious, but they’re there—including tilting a portion of your portfolio into riskier sources of expected return for long-term growth, fortifying these positions with stabilizing fixed income, and shoring up the entire structure with global diversification. 

This brings us to the real question: What should you do about today’s news? Unless your personal financial goals have changed, your best course is probably the one you’re already on. That said, we remain available, as always, to speak with you directly. Don’t hesitate to be in touch with any questions or comments you may have. 

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Bitcoin ETFs: Don’t Forget to Look Under The Hood

Some people hail Bitcoin as the greatest thing since sliced bread, while others consider it one’s worst enemy. Whether your conviction supports or berates the world’s most infamous cryptocurrency, it doesn’t change the fact that buzz around the crypto-space – inclusive of altcoins, blockchain, and decentralized finance – is rapidly growing. 

In fact, the Securities and Exchange Commission just approved the launch of ProShares Bitcoin Strategy ETF (Ticker: BITO), making this the first ever Bitcoin-centric exchange-traded fund. Before you take this as your cue to enter the cryptosphere, our team encourages you to take a good look under the hood.

What is there to find within BITO’s engine? First, BITO does not directly invest in Bitcoin, but buys futures contracts of Bitcoin. What’s the difference? When you buy a futures contract, you’re agreeing to buy Bitcoin at a specific price on a specific date in the future. For example, say you entered into a futures contract to buy Bitcoin on December 26, 2021 at $65,000. If the price of Bitcoin ends up higher than $65,000, say $70,000, you now lock in Bitcoin at $65,000 and are at a $5,000 profit. If the price is lower than $65,000, you will incur a loss.

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Since BITO tracks the futures price, not the spot (current) price, this can cause deviations in performance. In fact, “Solactive, an index provider, estimates futures have made about 13 percentage points less than bitcoin’s near 120 per cent rise so far this year” (Financial Times). Take for example, the United States Oil Fund (Ticker: USO), which invests in WTI crude oil futures. USO has underperformed the price of WTI crude by 70 percent this past decade. Moral of story: don’t expect a futures-based ETF to track the returns of the underlying asset one-for-one.

At first glance, buying the ETF seems much simpler: you don’t have to find a trustworthy custodian, set up an account, and deposit funds. However, there are nuances to this futures-based ETF that can make it more expensive. First, the expense ratio is 0.95%. Sure, you are paying the manager to decide which contracts to buy (these vary based on expiration dates, price, and liquidity), but this is still significantly above the average ETF expense ratio of 0.23%1. Compare that to a custodian like Gemini, where you are only paying 0.35% per transaction. 

Lastly, another hidden cost in this ETF is something called “negative roll yield.” Since you can’t hold a contract past its expiration date, the contract must be “rolled over,” or reinvested in before expiry. If you want to stay invested but front-month Bitcoin futures contracts are trading above the current spot price, you’ll have to sell your contract at a lower price and buy into the front-month contract at a higher price – generating a loss known as negative roll yield. Negative roll yield is a known culprit for negative returns in futures funds.

On a final note, Bitcoin futures aren’t absolute rubbish. When it comes to crypto assets, futures-based or not, position sizing appropriately can help provide meaningful diversification. However, we would encourage you to hold Bitcoin directly when possible. You can avoid nuanced costs such as negative roll yield and save on fees paid to intermediaries. Our team has the knowledge and tools to help you cross that bridge if and when appropriate. More importantly, the bigger takeaway here might just be: don’t forget to take a good look under the hood.

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Footnotes:

  1. ETFs vs. mutual funds: Cost Comparison

How Interest Rates Impact Your Chevron Pension

Rising interest rates have been a hot topic in the financial press, and many of my clients are wondering what the impact will be on their Chevron pension — specifically, their lump sum. 

As a retired Chevron employee, I understand these concerns firsthand! I monitored rates extraordinarily closely myself until I retired five years ago. The lump sum option is a great one for many people, but it is massively influenced by interest rates. Even a single percentage change in interest rates can dramatically impact your lump sum number via an inverse relationship. That is to say, as interest rates increase, your lump sum lessens. And as interest rates decrease, your lump sum grows. 

This gives you the potential to walk away with a large lump sum when you retire, but it also comes with the risk and emotional drain of fluctuating interest rates. One of my clients, for example, saw his lump sum drop from $1,080,000 to $1,040,000 in a 30-day period. Changes like that can be hard to swallow, and it’s particularly disconcerting when you don’t know how long these rate spikes will last. 

At Warren Street, we follow the tier 3 rates (the IRS segment Chevron uses to calculate your lump sum) extremely closely, so we can help you run projections for your specific case. Everyone’s situation is different, so I encourage you to give me a call if you are nervous at all, regardless of your current lump sum or retirement time horizon. However, in general:

  • If you’re thinking about retiring in the next 12-24 months or so, it might be a good time. Let’s run the numbers and see.
  • If you’re looking at two to five years or more for retirement, these interest rate spikes may not affect you. When they go back down, your lump sum will rise back up. Age and service credits will also help make up the difference from any interest rate changes.

If you’re finding yourself talking to your friends, coworkers, spouse, or others about this topic, give me a call — I will help you run the numbers so you can make an informed decision. The question of, “Do I have enough?” is never an easy one, and I’m here to help you understand all your options with data-driven insights so you can make the best choice for your family.

Feel free to contact me if you have any questions,