Schwab Intelligent Portfolios January 16, 2019

    When financial markets become turbulent it can be challenging to stay disciplined and focused on your long-term investment goals. These are the periods when investors sometimes let their emotions get the best of them and abandon their plans—potentially locking in short-term market losses. Times of turbulence underscore why it's so important to stick to time-tested investment principles like setting clearly defined goals as part of a long-term financial plan, investing in a diversified portfolio, and ignoring short-term market noise.

    As expected, market volatility returned in 2018 following an exceptionally calm period for financial markets throughout 2017.  While market turbulence can cause some anxiety, it’s important to remember that these types of rocky periods inevitably occur from time to time. Investing in a well-diversified portfolio as part of a strategic asset allocation plan can help prepare you to withstand the inevitable periods of turbulence. Sticking with your long-term plan and avoiding the temptation to sell in a panic is one of the most important disciplines for successful long-term investing.

    Schwab Intelligent Portfolios® is built on this foundation of asset allocation and diversification, with up to 20 asset classes in your portfolio. Defensive asset classes such as cash and gold play an important role, providing benefits of diversification that can help you weather these inevitable periods of market volatility.

    Defensive asset classes have helped offset stock market declines

    This understanding that markets can be volatile at times is why Schwab Intelligent Portfolios includes allocations to defensive asset classes such as cash, Treasuries, gold and international bonds as part of broadly diversified portfolios. Investors who hold defensive asset classes in their portfolios likely saw those investments play their important role of providing diversification and ballast during the recent market tumble, helping offset stock market declines.

    As Table 1 shows, U.S. large cap stocks were down 19.4% from their late September peak through December 24. Other stock asset classes fell even more, with U.S. small cap stocks down 26.1%, and international stocks down 13.6%. Notably, however, not all asset classes declined over that period. Cash remained stable, gold rose 5.0%, Treasuries gained 2.4%, and international bonds advanced 1.7%.

    Table 1: Defensive investments provided stability when stocks tumbled
    Asset Class Total Return
    U.S. Large Cap Stocks -19.4%
    U.S. Small Cap Stocks -26.1%
    International Stocks -13.6%
    Cash 0.6%
    Gold and Other Precious Metals 5.0%
    Treasuries 2.4%
    International Bonds 1.7%

    Source: Morningstar Direct, 9/20/2018–12/24/2018. Indexes used for each asset class are: U.S. Large Cap Stocks, S&P 500 Index; U.S. Small Cap Stocks, Russell 2000® Index; International Stocks, MSCI EAFE Index; Cash, Bloomberg Barclays U.S. Treasury Bill 1-3 Month Index; Gold and Other Precious Metals, S&P GSCI Precious Metals Index; Treasuries, Bloomberg Barclays U.S. Treasury 3-7 Year Bond Index; International Bonds, Bloomberg Barclays Global Aggregate ex-USD Hedged Index. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

    Defensive asset classes provide strong diversification relative to stocks

    While cash and gold are both considered defensive asset classes, each arrives at that characteristic in a different way. Cash has historically provided stability in the form of very low volatility, along with a lower return. By contrast, gold has produced a high return along with high volatility. Importantly, what these two asset classes share is a low to negative "correlation" with other asset classes such as stocks. This simply means that they tend not to move in lockstep with stock prices. When stock prices fall, they might remain stable or actually increase in value, as seen recently.

    Correlation is a statistical measure ranging in value from +1 to -1. If two asset classes have a correlation of +1, that means they rise and fall together in perfect synchronicity. A correlation of -1 indicates that they move exactly opposite to one another. A zero correlation means that they move independent of one another. The lower the correlation, the greater the diversification benefit provided by investing across those asset classes.

    As shown in Table 2, cash and gold have exhibited very low or negative correlation with stocks historically, providing strong diversification benefits. Because they don't move in lockstep with stocks, including these and other defensive asset classes in a portfolio can help investors to weather periods of market turbulence and stay focused on their longer-term objectives rather than overreacting to short-term market movements.

    Table 2: Defensive investments can provide important diversification relative to stocks
    Asset Class Correlation With U.S. Large Cap Stocks
    U.S. Large Cap Stocks 1
    U.S. Small Cap Stocks 0.82
    International Stocks 0.55
    Cash -0.03
    Gold and Other Precious Metals -0.12
    Treasuries -0.27
    International Bonds -0.16

    Source: Morningstar Direct, 12/1/2015–11/30/2018. Indexes used for each asset class are: U.S. Large Cap Stocks, S&P 500 Index; U.S. Small Cap Stocks, Russell 2000 Index; International Stocks, MSCI EAFE Index; Cash, Bloomberg Barclays U.S. Treasury Bill 1-3 Month Index; Gold and Other Precious Metals, S&P GSCI Precious Metals Index; Treasuries, Bloomberg Barclays U.S. Treasury 3-7 Year Bond Index; International Bonds, Bloomberg Barclays Global Aggregate ex-USD Hedged Index. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

    Defensive asset classes can help you weather periods of volatility

    It's important to remember that periods of market volatility occur from time to time. A disciplined asset allocation plan that invests in a diversified portfolio across a broad range of asset classes, including defensive assets such as cash, Treasuries, and gold, can help keep you focused on your longer-term objectives and avoid overreacting to short-term market volatility. Schwab Intelligent Portfolios is designed to provide broad diversification based on your financial goals and tolerance for risk.

    Additionally, automated rebalancing within Schwab Intelligent Portfolios accounts helps investors stay on track with their strategic asset allocation plan, efficiently imposing a "buy low-sell high" discipline as markets fluctuate. This can be challenging during periods of market stress, so an automated rebalancing process can help take emotion out of the decision-making process. And automated tax-loss harvesting for accounts with $50,000 or more, allows investors to take advantage of market volatility by capturing losses that can be used to offset capital gains elsewhere in their portfolio, helping to reduce current tax liabilities and leave you more money to reinvest and potentially grow over time.

    Sticking to a long-term strategic asset allocation plan through the inevitable periods of market volatility along with a disciplined process for rebalancing and tax-loss harvesting are key components for achieving long-term investment success.

    David Koenig CFA®, FRM®, Vice President and Chief Investment Strategist for Schwab Intelligent Portfolios®

    Charles Schwab & Co., Inc. and Charles Schwab Bank are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation. Brokerage products, including the Schwab One brokerage account, are offered by Charles Schwab & Co., Inc., Member SIPC.

    Deposit and lending products are offered by Charles Schwab Bank, Member FDIC and an Equal Housing Lender.

    The S&P 500® Index is a market-capitalization weighted index that consists of 500 widely traded stocks chosen for market size, liquidity, and industry group representation.

    MSCI EAFE® Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI EAFE Index consists of the following 22 country indices: Australia, Austria, Belgium, Denmark, France, Finland, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

    The Bloomberg Barclays Capital 1-3 Month U.S. Treasury Bill Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. In addition, the securities must be denominated in U.S. dollars and must be fixed rate and nonconvertible.

    The Bloomberg Barclays U.S. Treasury 3-7 Year Bond Index measures the performance of public obligations of the U.S. Treasury that have a remaining maturity between three and seven years.

    The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

    The LBMA Gold Price PM Index measures the performance of setting price of gold, determined twice each business day on the London bullion market by the five members of The London Gold Market Fixing Ltd. It is designed to fix a price for settling contracts between members of the London bullion market, but informally the gold fixing provides a recognized rate that is used as a benchmark for pricing the majority of gold products and derivatives throughout the world's markets.

    The cash allocation in Schwab Intelligent Portfolios Solutions™ will be accomplished through enrollment in the Schwab Intelligent Portfolios Sweep Program (Sweep Program), a program sponsored by Charles Schwab & Co., Inc. By enrolling in Schwab Intelligent Portfolios Solutions, clients consent to having the free credit balances in their Schwab Intelligent Portfolios Solutions brokerage accounts swept to deposit accounts at Charles Schwab Bank through the Sweep Program. Charles Schwab Bank is an FDIC‐insured depository institution affiliated with Charles Schwab & Co., Inc. and Charles Schwab Investment Advisory, Inc.

    Accounts must maintain a minimum balance of $5,000 to be eligible for automatic rebalancing.

    Tax‐loss harvesting is available for clients with invested assets of $50,000 or more in their account. Clients must choose to activate this feature. The tax‐loss harvesting feature that is available with Schwab Intelligent Portfolios Solutions™ is subject to significant limitations which are described on the Schwab Intelligent Portfolios Solutions website and mobile application (collectively, the "Website") as well as in the Schwab Intelligent Portfolios Solutions™ disclosure brochures (the "Brochures"), and the IRS website at www.irs.gov. You should consider whether to activate the tax‐loss harvesting feature based on your particular circumstances and the potential impact tax‐loss harvesting may have on your tax situation. You should read the tax‐loss harvesting disclosures on the Website and in the Brochures before choosing the tax‐loss harvesting feature. Neither the tax‐loss harvesting strategy nor any discussion herein is intended as tax advice, and neither Charles Schwab & Co., Inc. nor its affiliates, including but not limited to Charles Schwab Investment Advisory, Inc., represents that any particular tax consequences will be obtained.

    Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ are designed to monitor portfolios on a daily basis and will also automatically rebalance as needed to keep the portfolio consistent with the client’s selected risk profile. Trading may not take place daily.

    The S&P GSCI Precious Metals Index provides investors with a reliable and publicly available benchmark for investment performance in the precious metals market.

    The Bloomberg Barclays Global Aggregate ex-USD Hedged Index measures the performance of global investment grade fixed-rate debt markets that excludes USD-dominated securities.

    (0319-99H0)


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