Diversify to Prepare for Potential ‘Bubbles’ in Future

Like the housing-market bubble that burst in 2008, and the dot-com bubble of 1999, the swell-and-burst scenario is actually fairly common. But not pleasant. Burst bubbles have a wide impact on the overall economy. Now, experts are discussing whether the current environment is ripe for a bubble.

Market bubbles occur when an economy or market has become unbalanced due to a flawed outlook – as it was in the 1990s when investors were excessively bullish about technology stock, driving their prices to levels that did not reflect reality.

According to brokerage firm Charles Schwab, the four most likely bubbles to occur today are cryptocurrencies (such as bitcoin); volatility; Internet retailers; and central-bank assets. Pointing to the yield curve, which has historically detected bubbles about to burst, Schwab suggests there is a relatively modest risk of a bear market during the next 12 months.

There are many factors that influence markets, including Federal Reserve policy and inflation. These and other factors can impact investors’ comfort levels, meaning they’re more likely to try to reduce investment risk. Diversification is one popular option among investors who are concerned about an impending bubble. Most believe that diversification may provide protection in the event of a bear market; diversifying into stocks, bonds, cash, and possibly real estate and commodities may smooth out the highs and lows.

If you’re concerned about the potential for an upcoming bubble, discuss it with your advisor. He or she is close to the action and may know better than others what’s happening now and in the future.

You Can Take Back (Some) Control Over Taxes

It’s a truism: Every investor is concerned about minimizing taxes. But the good news is you can have some control when it comes to this often frustrating exercise.

Mutual-fund investors, in particular, have concerns about tax management strategies; funds may sell individual stocks that have appreciated, creating a capital gain for investors even if the performance of the fund itself is down. But others are impacted by capital-gains taxes and concerned about income-tax treatment, too. We’re all looking for solutions.

Generally, purchasing securities in different accounts based on how those accounts are taxed can help. Investments that lose more of their return to taxes (such as stocks) could be purchased in tax-advantaged accounts, for example. And for investments such as municipal bonds that lose less of their return to taxes, taxable accounts might be a good choice.

Diversify by tax treatment

You may also want to diversify your investments by tax treatment. For example, if you’re considering a traditional IRA or a Roth IRA, one solution may be to split your contributions between the two. So when it’s time to withdraw money in retirement, you can choose which account to take the cash from, depending on whether you’re in a high tax bracket (the Roth IRA) or a lower tax bracket (the traditional IRA).

When it comes to gift taxes, different accounts are treated differently. For example, securities that have appreciated in your taxable accounts can be donated to registered charitable organizations for a fair-market-value deduction and no capital gains tax. And there are also different rules for estate planning.

These both can be complicated: Consult with your advisor, who is familiar with your situation and up to date on the most recent rules.

Finally, however you use different accounts for tax management purposes, remember you have a single portfolio for asset-allocation purposes. Your advisor can also help you keep this straight.