To Trade, or Not To Trade
That is the question:
Whether ‘tis nobler in the portfolio to suffer
The slings and arrows of outrageous capital gains,
Or to take arms against a sea of losses,
And by realizing end them?
We field many questions from clients (though they’re not usually phrased in iambic pentameter). Some of those questions are focused on the investments and the trading activity (or lack thereof) that appears on the monthly statements. Often clients wonder why we placed those trades. Have we changed our outlook for the securities in question? Are we rebalancing the portfolio? Is it something else?
The answer: it depends. When you see trading activity in your account, it generally falls into three main categories: raising or investing cash, rebalancing, and block trading. Unfortunately, you won’t know by looking at the trade into which one of these categories it falls, but perhaps by illuminating our general process and rationale at least some of the mystery will be dispelled.
There are many reasons to place trades for cash movement: automated monthly withdrawals or deposits, RMDs out of IRAs, and other client-directed deposits or withdrawals. We keep our clients’ accounts as fully invested as possible given their individual cash needs, but will occasionally have to place a trade to make more cash available (or to invest a deposit).
When we are investing a deposit, we are trying to manage to the client’s investment objective. Does the account need more equities, or is it low in fixed income? Which sectors are underweight? Within those sectors, which of our preferred securities are lacking? As you can see, we start at the highest level and work down to the individual security level. Cash deposits help to keep the accounts in balance by allowing us to focus on the areas that are underweight.
In much the same way, trades placed in order to raise cash help us trim the overweight areas, again by looking at asset class, sector, and individual security. In taxable accounts we must take capital gains and the client’s tax situation into consideration, so sometimes the trades are chosen for tax efficiency. When we are selling securities to raise cash, it’s not because we’ve changed our outlook for those particular securities, but more to achieve an objective (creating available cash) while also rebalancing the account in a tax-efficient manner. It can be quite challenging at times.
It is our responsibility to manage our clients’ portfolios to their stated investment objective. Normal market movement will eventually necessitate routine rebalancing trades, which serve to trim overweight areas and add to underweight areas (as described above), even in the absence of cash movement into or out of the portfolio. Think of it like gardening – you trim a little here and plant a little there to keep everything healthy and flourishing.
So when DO we place trades because we’ve adjusted our outlook on a given security? When we block trade! In the course of our due diligence (as we are routinely reviewing securities under coverage), we identify securities that have fallen from favor for some reason, whether it’s overvaluation, deteriorating fundamentals, or company-specific risk factors. In these situations we may choose to sell the security for all clients at the same time. Sometimes we use the proceeds to initiate a position in a newly-approved security, other times we use the proceeds to correct an imbalance in a client’s portfolio. The latter scenario explains why two people in the same household may see the same security sold but a different security purchased. We follow the same general approach for all clients but tailor it according to each individual client’s needs.
Tax-Loss Harvesting Trades
Towards the end of the calendar year we focus on placing loss harvesting trades in taxable accounts, to offset realized gains that have accumulated throughout the year from the types of trades mentioned above. In this way, we can minimize the tax liability on our clients’ investment portfolios. While those are the four primary types of trading activity clients may see in their accounts, it is important to note that occasionally there may not be any trading activity. That doesn’t mean the account has been overlooked, however, as we are constantly monitoring our clients’ accounts and the securities within them.
What about the times when there is no trading activity? Does that mean we’re not looking at your account? Absolutely not! We are constantly monitoring your accounts and our covered securities within them. Believe it or not, sometimes there isn’t any reason to place a trade. Though trading fees are the lowest they’ve ever been, there is a hidden cost to frequent trading and high portfolio turnover which has been shown to negatively impact performance. We maintain a range around asset class, sector, and security weights so that we aren’t constantly rebalancing back to target. In short, we don’t believe in placing a trade unless there’s a good reason to do so.