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It was the year of unpredictability.
The pandemic, including self-quarantine for months, is a priority for people around the world. The many other surprises this year include the fastest bear market in history, civil unrest, a very unique US presidential election, the rapid creation of a coronavirus vaccine, and the market hitting all-time highs despite the scary headlines.
No one could have predicted how this year would unfold.
With so much uncertainty, the only strategy that will be particularly relevant to investors in 2021 is “investor alpha”. Basically, factor-driven alpha investing strategies are designed to manage risk within a portfolio while delivering market-leading returns.
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Many people know the alpha of the manager, or the additional return that an effective portfolio manager can provide above the index. However, with choppy markets and a continuous stream of bad news, it would be wise for investors to focus on the alpha that they can personally generate by paying attention to the four concepts below.
1. Tax efficiency: A tax-efficient portfolio allows investors to keep more of their money. This can be accomplished by using an appropriate âasset locationâ, a process of placing investments in different types of accounts based on their tax efficiency.
For example, tax inefficient investments, such as real estate investment trusts and funds with high portfolio turnover or that generate a high level of income, may be better suited for tax-deferred retirement accounts. Conversely, tax-advantaged investment strategies like exchange-traded funds that passively track an index and generate a modest level of income may be better suited in a taxable account.
Another way for investors to minimize their tax liability is to maximize their contributions to tax-efficient accounts. This includes 401 (k) plans, individual retirement accounts, Roth IRAs, or a tax-free triple health savings account. If one has kids in college, this may also include a 529 University Savings Account, which offers tax-free federal growth and tax-free withdrawals for qualifying expenses, as well as the ability to ‘a tax credit or deduction for contributions to its state-plan. Paying close attention to taxes, in addition to investments, can dramatically increase one’s wealth over time.
2. Savings rate: Over the past decade, the S&P 500 Index has delivered an attractive annualized return of 13%, several points above the historical long-term average of 10%. While all investors look for strong and continued performance, it is prudent to anticipate the possibility of lower future growth.
The market moves in cycles and can experience years of relative underperformance. For example, the S&P 500 averaged -3% per year over the decade ending February 2009.
One step that investors can take in planning for a low-yielding environment is to increase their savings rate. It is much more exciting to pick a winning stock or watch the market reach historic highs. However, just setting aside more money is a more reliable way to reach your financial goals.
3. Automation: One of the hardest things about investing is controlling your emotions. When the market collapses, many investors want to sell everything and switch to cash. On the flip side, as the market soars, many feel the need to chase high-profile stocks and take a reckless level of risk.
Instituting a level of automation in your investment process is a good way to control emotions and keep your investment strategy on track. Investors can effortlessly execute this strategy through their employer’s 401 (k) plan, where the money is automatically deducted from every paycheck and invested in the market. Investors can also subscribe to an âautomatic indexationâ of contributions to ensure that they effortlessly contribute more money each year. The same automations can be set up in a brokerage account by working with your financial advisor.
Another automation is the rebalancing process, which readjusts the weightings of a portfolio as an investment rises or falls over time. When a portfolio is rebalanced, the investor buys or sells assets in order to maintain their original asset allocation. They also sell high and buy low, which is a way to lock in gains and reinvest the proceeds in investments that have underperformed. Rebalancing can be configured to occur at predetermined times throughout the year or once an investment reaches a certain percentage threshold relative to the rest of the portfolio.
4. Wallet costs: Two of the major recent advances in the investment world have been the democratization of investment solutions and the substantial reduction in fees throughout the industry. Today, US-based investors can gain exposure to almost any market in the world for a small fee. This exposure can be achieved in a number of ways, including easily accessible exchange traded funds or low cost mutual funds.
An interesting exercise for any investor is to comb through their existing holdings to see if they can swap expensive legacy positions for new low-cost investments. While fees are certainly not the only consideration, or even the most important factor, when it comes to accumulating wealth, paying significantly more than the industry average can reduce your returns over the course of your life. investor.
As the end of the year approaches, people can only guess what 2021 has in store for society and the markets. If we’ve learned anything from the past year, it’s that none of us have this crystal ball that can help us predict the future. However, investors can take comfort in the fact that focusing on things they can control may be enough to achieve their financial goals.