Stocks experienced a significant rise in a delayed relief rally on Thursday, following the Federal Reserve’s substantial interest rate cut on Wednesday. Despite this initial surge, there are concerns about potential market volatility ahead, prompting investors to prepare accordingly. The excitement over the Federal Reserve’s half-point rate cut pushed the S&P 500 over the 5,700 threshold for the first time on Thursday. However, Goldman Sachs has cautioned that investors should brace for possible market turbulence.
Analyst Arun Prakash of Goldman Sachs noted in a Thursday report that the CBOE Volatility Index (VIX) has historically increased by 6% from September to October over the past 30+ years. His team anticipates that current VIX levels could rise due to seasonal factors and upcoming macro and microeconomic catalysts. These catalysts include the third-quarter earnings reports scheduled for October, the general election on November 5, and the final two Federal Reserve meetings of 2024 in November and December.
Rafia Hasan, Chief Investment Officer of Perigon Wealth Management, highlighted the typically increased volatility during election years, especially leading up to the major vote in November. Hasan emphasized the importance of understanding one’s risk tolerance and ensuring that asset allocation aligns with long-term goals to protect portfolios from sharp losses. She has employed strategies such as tax loss harvesting and direct indexing to capitalize on market fluctuations.
Hasan explained that direct indexing allows investors to manage individual stock holdings, unlike an index exchange-traded fund (ETF) that acts as a collective basket of securities. By selling off underperforming stocks, investors can harvest losses to offset taxable capital gains. If losses exceed capital gains, they can offset up to $3,000 in ordinary income, with the excess carried forward to future years. Hasan cited a market downturn on August 5 as an example of an opportunity to harvest losses.
In addition to equities, bonds remain an attractive option for investors. Despite the Federal Reserve’s rate cuts, bonds are offering more appealing yields compared to the past decade when rates were near zero. Hasan supports municipal bonds for higher-income clients because of their tax-exempt status on a federal level and often on state and local levels. She has been adding bonds with greater price sensitivity to interest rate moves, targeting a duration of five to seven years.
Similarly, Andrew Herzog, a certified financial planner at The Watchman Group, has been increasing exposure to bonds, particularly focusing on quality. He prefers investments like the iShares 1-3 Year Treasury Bond ETF (SHY), which currently offers a 30-day SEC yield of 3.74% and charges an expense ratio of 0.15%. Herzog emphasized that rate cuts could enhance fixed-income capital gains, making it wise to shift some wealth into bonds.
Options are another tool being utilized to mitigate volatility in investment portfolios. Covered calls allow investors to generate premium income while holding the underlying security, though it requires readiness to sell the stock. Buffer ETFs, or defined outcome ETFs, are gaining traction, especially among near-retirees concerned about market stability. These ETFs combine call options with put spread strategies to limit losses up to a certain threshold.
Gregory Guenther, a retirement planner at GrantVest Financial Group, stressed the importance of managing portfolio risk, noting that buffer ETFs can be effective tools for this purpose. However, he acknowledged that these instruments require thorough due diligence, including understanding the timing of purchases and associated fees, which typically range from 0.75% to 0.85%.
Ultimately, investors are urged to stay informed and consider various strategies to navigate potential market volatility effectively.
