With the S&P 500 down over 20% this year so far and the NASDAQ even more so, many are understandably concerned. However, there are some great opportunities in the stock market it down. Here is our list of top 5 things to do in a down market.
1. Stick to your Strategy: When the market starts to drop it is easy to let emotions take over but selling due to fear is rarely a good decision. Keep your emotions in check. Do not panic sell. Turn off the news if necessary. Review your financial plan and stick to it.
According to research by Massachusetts Institute of Technology (MIT), over 30% of investors who panic sold assets after previous downturns never got back into the stock market. Those who leave the stock market and don’t return miss out on recoveries.
Selling and moving to cash to wait for better times requires that you predict well twice - once when you sell and once when you buy again. Without being able to accurately predict timing you likely miss out on some of the overall market performance. Furthermore, some of the best days for the stock market historically often follow the worst days. When compared to overall market performance, missing out on those returns locks in permanent underperformance. To get all the returns in the stock market you also have to get the downturns too.
2. Save and Invest: For long-term investors a drop in the stock market can be a great time buy. Find as many ways as possible to save money on things you don’t care about and put more money in stock funds since stock prices are down. For example, if you have been wanting healthier home cooked meals instead of eating out as often, for example, now is the time. Then use whatever savings you can to invest.
3. Rebalance your portfolio: When stock prices drop, bond prices often rise. While this year has been an exception to this rule, bonds have still been much more stable than stocks, which means your portfolio can get of balance with your planned strategy. Rebalancing when stock prices drop means selling some of the bonds (with often higher values when stocks decline) and purchasing the lower priced stocks. In other words, this not only ensures that you are sticking with your planned strategy but also means that you are relatively speaking, buying low and selling high.
4. Take advantage of loss harvesting: If you have a taxable brokerage account (as opposed to a retirement account such as an IRA or 401k), you may be able to take advantage of tax loss harvesting.
When you sell a portfolio asset at a loss you create a capital loss for income tax purposes. This can be used to offset capital gain income. But, even if you do not have capital gains this year, you may generally use up to $3,000 in capital losses to offset ordinary income.
However, to take advantage of the tax loss, you cannot immediately re-buy “substantially identical securities” for 30 days. You may, however, buy something different but in the same asset class immediately to both keep invested and keep your portfolio in line with your overall investment strategy.
Generally, individuals wait until November or December to make sure they have a clear picture of their taxable capital gains and losses for the year before determining a tax loss harvesting strategy. We would be happy to look at your specific situation, run a tax projection if necessary, and determine if this strategy makes sense for you.
5. Consider a Roth conversion: In a Roth conversion, assets from a traditional IRA account are transferred to a Roth IRA account with applicable income taxes paid in the year of the conversion. The Roth assets then grow tax free. They are not ever taxed when withdrawn or passed to an heir.
When market prices are down, you are able transfer more shares for the same dollar amount compared to when prices are up. This gives you more shares to pursue tax-free growth over the long term. We would be happy to do further analysis to determine if a Roth conversion makes sense for you.