How to use a bear market to your benefit - Ep #76
Welcome to episode 76 of the One for the Money podcast. I am both glad and grateful you have taken the time to listen. In this episode, I’ll share how you can use a drop in the stock market to your advantage
In the tips, tricks, and strategies portion, I will share a handy rule of thumb regarding knowing if you are on track for retirement.
In this episode...
Opportunities in Down Markets [0:59]
Investment Strategies During Market Declines [2:55]
The Historical Behavior of the Stock Market [11:10]
MAIN
Better Planning Leads to a Better Life, and that can especially be the case in down markets. Many people fear stock market downturns but hopefully at the end of this episode you are able to see the silver linings amongst the rain clouds. In fact that reminds me of a fantastic quote by one of the world’s most famous investors, Mr. Warren Buffett.
He said and I quote ““Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble.”
This speaks to the tremendous opportunities that a down market can present, but you have to have the stomach to handle them. During such times it’s easy to get gripped by fear and I don’t blame people as losses are incredibly hard to stomach. In fact losses are twice as impactful for investors than equivalent gains. Studies have shown that a 10% loss hurts twice as much as a 10% gain. I know this from personal experience when very early in my time as an investor, I purchased a stock that then dropped 50%. I sold out only the stock since that time to increase over 7,900%. that’s right, instead of selling I should have bought more and enjoyed a nearly 8 thousand percent gain. For more details on this painful lesson see episode 18 of this podcast entitled, When Life Gives You Lemons, Stay Invested.
With a pessimistic mindset, you can make really poor decisions and miss incredibly once-in-a-generation type of opportunities, as I did, but with the right mindset you can see the economic rain storms, and instead of running for cover,r you grab a bucket as Warrant Buffett said so well. And when you employ these better investment strategies it will make for an even better life.
Here are the strategies to consider based on how far down the market is. I’ll use each calendar year, January 1st, as the starting point.
Here is what one should do when the stock markets are down 5%.
If the stock markets are down 5% from where they were on January 1st, there really is nothing one should do other than stay the course. Drops in this magnitude are far more typical than one might imagine. In fact, in the last 44 years, the stock market has been down on average 14.2% at some point during the calendar year. So at one point between January 1st and December 31st of every year since 1980, the stock market was down around 14% on average, and yet, 33 of those 44 years, the markets ended up higher on December 31st than where it had started on New Year’s Day.
Most times the best thing you can do is nothing at all.
Here is what one should do when the stock markets are down 10%, the definition of a correction.
Your first option is to do nothing and stay the course but there are also some ways to take advantage of these likely temporarily lower prices.
The first consideration is to rebalance your accounts. For example, let’s say you have identified a portfolio of 80% stocks and 20% bonds to be your ideal portfolio to help achieve your goals. Now let’s also say there is a drop in the stock market of ~10% and this causes the stock holdings to go down to 70% from 80%. Alternatively, the bonds portion of your portfolio rises from 20% to 30% in this hypothetical example. Rebalancing merely, shifts your portfolio back to its initial distribution, so 10% of bonds or bond funds are sold and 10% of stock funds are purchased to get back to your original ratio of 80% to stocks and 20% to bonds. This enables you to buy stocks while they are lower priced. This was a huge win for my clients during the Covid crash because I rebalance client accounts on a quarterly basis. We were fortunate in the market low just happened to occur on March 23rd. Stocks had crashed as much as 34% on that date and so when clients accounts were rebalanced on March 30, they were able to purchase stock at these very low prices. In fact stocks, represented by the S&P500 were up 50% at the end of 2020 from the low point on March 23rd, 2020.
Other strategies you can consider when markets are down 10% that are specific to retirement accounts are as follows. You could accelerate retirement plan contributions. Instead of spreading contributions over the year, you could increase those contributions when markets are down 10%. Of course, the stock market could go down further so you could also keep your recurring contributions as they are. However, one additional consideration is to initiate partial Roth conversions.
Roth conversions work just as they sound, you convert portions of your not-yet-taxed retirement accounts to never-again-taxed accounts. There are no income limitations but since you will be paying income taxes in the year of the conversion it makes the most sense to complete Roth conversions in the years when your income is lower. For example, if you work part-time in the years prior to full retirement that would be a great time to consider Roth Conversions. There are many factors to consider so be sure to speak with the right CFP.
For those with Non-Retirement Accounts you can consider Tax Loss Harvesting. That’s where you sell investments with gains to offset those with losses. For example, let’s say you purchased stock ABC for $5000 and it’s now worth $10,000. Let’s say you also purchased stock DEF for $7500 and it’s now worth $5000. You could sell both stocks and the $5000 gain in ABC would be offset by the $2500 loss in DEF so you’d only be taxed on $2500. Please note, that you have to wait more than 30 calendar days before you purchase stock DEF otherwise it would negate the offset due to wash sale rules.
I usually conduct tax loss harvesting in the fall each year and occasionally during the year if conditions allow for it.
What strategies should one consider if stock markets are down 20% or more, What is the definition of a bear market?
Generally, they are the same strategies you would consider when the stock market was down 10%. If the stock market was down 20% from where it was on January 1st again you will want to definitely consider Rebalancing to increase your exposure to stocks. In retirement accounts, it’s straightforward as there are no taxable implications but with non-retirement accounts those need to be considered. Also regarding retirement Accounts you will want to further expedite Roth Conversions and/or accelerate retirement account contributions (Roth or Traditional). Again for those with Non-Retirement Accounts you will want to consider tax Loss Harvesting.
And for those who are already retired, you will want to assess if you need to make adjustments to your income distributions and only take distributions from dedicated income sources (ie conservative investments). We implement income guardrails for our clients and adjust their income lower or higher based on market events. Clients are often surprised how much their investments drop before they would have a drop in their income.
What if stock markets are down 30%, One of those rare moments when it can rain gold.
If markets are Down 30%, this may surprise you but it really is more of the same. Rebalance your stock and bond ratio to increase your exposure to stocks. With Retirement Accounts - Expedite Roth Conversions &/or Contributions and with Non-Retirement Accounts - Tax Loss Harvesting. For those that are Retired take distributions from dedicated income sources and Confirm one hasn’t hit your Income Guardrails.
All of this of course is easier said than done. When markets drop, especially when they do so steeply it can be a challenging time. For this reason, one should always invest according to one’s goals and in alignment with time-tested investment principles but that shouldn’t prevent you from taking advantage of when the market provides opportunities. As Warren Buffett also said, when people are greedy get fearful but when people are fearful get greedy or better yet, get a plan for a better life.
This is a way better option than the alternative, which is selling your stocks.
The last few years have offered more than enough unprecedented events, the stock market included. Back in 2020, with the global pandemic shutting the world down we had the fastest bear market which is more than 20%, it just took 16 days for that to happen and then dropped further still. But only a short time later the stock market rocketed higher with the fastest 50-day rally in history, and later still with one of the fastest 100-day rallies in history.
But it was those who reacted to the losses that really were impacted financially. Fidelity manages over $4 trillion dollars and they found that close to one-third of their investors over the age of 65 sold all of their stocks during the Coronavirus meltdown*. Unfortunately, because they sold, their investments missed out on these significant rallies to the upside. Here’s a great quote from the WSJ article at that time “People tend to sell after an economic downturn is already priced into equity markets, By selling at this time, investors are locking in their losses”
Maybe these facts regarding stocks will be helpful to people to take advantage of stock market downturns:
Over the past nearly 100 years, the U.S. stock market
is up nearly 75% of the time (3 out of every 4 years)
And 60% gains in excess of 10%.
More than 33% of the time gains are 20% or more
25% of the time the market will be down
So you are more likely to gain 20% or more than experience a down year.
TIPS, TRICKS AND STRATEGIES
Welcome to the tips, tricks, and strategies portion of the podcast where I will share a few end-of-year financial planning tips so you make the most of your money before the end of the year.
As I’ve heard it said, the days are long but the years are short and that phrase seems especially true in December when many wonder where did the year go. But there is still time to make some smart money decisions for the year. Often times this planning can’t wait until January since taxes are looked at on a calendar basis. So most things have to be completed on or before December 31st.
Of course, any of this planning needs to be viewed through the lens of your financial plan which in turn is aligned with your ideal life.
This year-end planning especially needs to be considered in years when there were significant life changes such as births, deaths, marriages divorce, or retirement as these can have a significant impact on your personal finances and your strategic financial plan.
The first planning tip is to confirm you are contributing as much as you can to your 401(k) or Simple IRA account contributions. These contributions need to be made by the end of the year. If you aren’t able to max these out did you at least contribute as much as the company match?
Another year-end planning tip is to ensure you are contributing as much as you can to your health spending account (HSA), should you have one. You want to ensure you receive a tax break for any medical expenses you would need to pay for.
Another year-end planning tip is to ensure you use up your FSA. HSAs don’t have to be used every year but FSAs have to be spent by the end of each year. There are some qualified products you may not have thought of, from contact lens solutions to bandages, that you can purchase with those funds.
One of the biggest end-of-the-year planning strategies is directly related to taxes. For example, based on your anticipated income for next year, would defer or accelerate any bonuses, property sales, other taxable transactions, deductible expenses, charitable gifts, etc., benefit you from a tax perspective?
Examples include paying your January mortgage early as you could deduct the interest on your 2024 tax return.
You will also want to look at your charitable contributions
For example, If you plan to donate the same amount of money each year, consider “bunching” the donations into a single year. This could increase your potential itemized deductions for that year.
This is just one of many end-of-year considerations.
References
Retirement Income Worries Often Overblown, Survey Shows
18 To-Dos For Your Year-End Financial Planning ChecklistConnect with Jonny West
Connect with Jonny on LinkedIn
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