Now that the election is in our rearview mirror, it’s time to check our investment portfolios for any necessary end-of-year adjustments. The turbulence of 2020 will have a lasting impact on our lives and our portfolios so it’s important to proactively prepare for what may lie ahead. In this article I’ll describe some end-of-year strategies that you may want to consider.

First, let’s looks at the standard end-of-year tweaks. One tried and true investment practice is “rebalancing” (i.e., the practice of periodically buying or selling portfolio holdings based on performance). In other words, you reduce the investments that have appreciated the most and buy investments that have underperformed. For 2020, it’s been a wild ride but both U.S. stock and global bond portfolios have generally risen year-to-date. Interest rate reductions drove bond investments higher while low rates plus government income subsidies are generally listed as the reasons for the equity market surge following the March meltdown. In general, 2020 market performance has been driven by “mega cap technology”, while some smaller capitalization asset classes along with “Value” asset classes have lagged.

Another classic year-end adjustment would be to offset any capital gains with capital losses. When you buy and sell investments you generate a capital gain or capital loss based on the price change from when you purchased the investment. If you finish a year with a positive capital gain from the trades in your portfolio, you will generally pay taxes on the gain. Tax rates vary by income and holding period but can be as high as your income tax rate. As such, many investors seek to make year-end adjustments to mitigate this tax burden. The classic strategy is to sell some of your investments that have depreciated since the purchase date. Losses can generally be used to offset gains thereby reducing your current year tax burden. Please note that trades must be completed by 12/31 to realize this benefit. It is important to note that, for 30 days following a sale, you may not re-purchase an investment or the trade will be considered a “wash sale” by the IRS and the loss will be disallowed.

Aside from the standard end-of-year adjustments, the question remains about how to position portfolios for 2021. It’s hard to remember a time where it is more difficult to predict where things are headed. This brings us to another classic investment concept (i.e., diversification). Strong portfolios are created with investments that provide income and/or capital appreciation but have different performance in varying market conditions. The lack of correlation among investments helps to lower overall investment volatility and thereby improve performance. I’ll discuss a few ideas below for improving your portfolio’s diversification heading into 2021.

First, given the ongoing battle with the COVID-19 pandemic, there is a high likelihood that another relief package will get approved. The timing remains unknown but many believe more government assistance is coming. Although it will not be a stated intention of any relief package, it is well documented that past injections of liquidity  have contributed to asset price inflation including the stock market. Second, it is likely the Senate will remain in Republican control and therefore we will have a “divided” government. Without Democratic control, it will be harder for President Elect Biden to get all of his policy proposals passed which include increasing the tax rate on capital gains and corporations – both of which would be viewed unfavorably by the stock market. Third, the Fed has given strong guidance that they will keep the Fed Funds rate at or near 0% for an extended period of time – a huge benefit to public companies.

Still, with rates near 0% and low inflation, it is a precarious set-up for the bond market.  If rates or inflation ever begin to rise, it would be adverse to bond prices. While inflation isn’t likely to be an immediate problem given the deflationary impact from COVID-19, it could pick up in 2021. We’re seeing some factors that could contribute to inflation down the road including the following: a rapidly growing money supply, an increased willingness to provide direct cash payments to individuals that are not offset by higher taxes, improving growth prospects in emerging markets and a general trend toward anti-globalization (i.e., a desire to see more local production in place of lower-cost overseas production). Given the potential for inflation, investors may consider rebalancing into some assets that would likely appreciate in an inflationary environment. Commodities, precious metals, real-estate and other “real” assets, like timber or farmland, are all generally good hedges for inflation. Moreover, historically, home prices have outpaced the inflation rate so owning a home can also help to hedge your overall portfolio from a surge of inflation.

In summary, it’s impossible to predict the future so our portfolios have to be prepared for multiple potential outcomes. Diversification and rebalancing are as important as ever given the rapidly changing environment and increased volatility