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What Should I Be Doing In A Down Market? Thumbnail

What Should I Be Doing In A Down Market?

Investing

About the Author
David Fulton is a Colorado Springs, CO fee-only financial planner providing Hourly and On-Going Financial Planning and Investment Management.  While he works with a broad range of clients, David specializes in working with Active and Retired MilitaryFederal Employees, and Families with Special Needs Children.
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If you're like most people, the last two months have been emotionally draining.  The market crashed, then it sputtered back to life, and rose, and fell, only to rise again. Not only have you had to battle the uncertainty of a pandemic, but your retirment fund likely took a beating that has left you wondering if you are doing the right thing.  While stocks have recovered many of their sharp losses, the uncertainty of long term impacts to our economy and the damage caused by mass unemployment hangs heavily over our heads. Many economists are describing a "W" shaped recovery, inferring another large market drop is just around the corner. When the market inevitably drops again (which it will, because that's what it does), do you know what will you do? How did you react in the midst of the market plummeting the first time?  If you were unnerved and already sold, or have a lingering fear about what may happened next you are not alone.  You may be envisioning dollar signs flying out of your wallet and you want to get on the phone and sell.  Or perhaps you have a backbone of steel and saw an opportunity to buy.  During these times I am best reminded of Nobel Laureate Eugene Fama who once said:

"Your money is like a bar of soap.  The more you handle it, the less you'll have."

So what should you do during times like these?  Afterall, sitting on your hands might be the hardest thing to do.

1. Keep a Balanced Portfolio

Having a balanced portfolio can help to balance the risks you are taking and the return you hope to achieve. Balanced portfolios typically consist of a mixture of stocks and bonds which are thought to be negatively correlated, meaning, when stocks fall, bonds usually rise. Overtime, your bonds increase in value and your stocks have taken a beating.  Your portfolio naturally becomes out of balance, with your bonds taking up a greater proportion of your portfolio.  During a volatile market, you will want to periodically rebalance by selling other assets like bonds or even commodities. Then you can invest in stocks that are down in price. It’s not a panic buy; it’s a strategic move that fits your original investment plan by taking your portfolio back to the ratio of stocks to other assets. In effect, you are buying low and selling high, and investing like a pro!

2. Resist Panic Selling

Typically panic selling is triggered by events that may lower the confidence level of investors causing them to sell and when this occurs on such a wide scale sharp declines in pricing tend to occur. Selling in a rush to get out of a down market could have long-term implications and often times cause you to miss out on some big gains when the market corrects. JP Morgan produced a great illustration to show just how dangerous it is to sell and sit on the sidelines waiting for a sign that it is safe to come back in. 

 

Six of the best 10 days occurred within two weeks of the 10 worst days! If you missed those 10 days, your returns were cut in half! You likely remember March 24th, 2020. In the midst of the steepest sell off in market history, in one single remarkable day the market gained +11.37 %; the fourth best trading day in history. As the saying goes "its about time in the market, rather than timing the market" that creates wealth. The moral....stay invested.

3. Consider Taking Advantage of Tax Laws

Many financial advisors suggest a strategy to create tax losses to offset capital gains by selling an investment. If your gains are less than your losses, you can claim up to $3000 of  those losses on your tax return and you can carry over losses greater than the amount you can claim on your annual return to another tax year. This strategy is referred to as tax-loss harvesting. Taking advantage of a market sell off to sell some of your overweight positions could be advantageous in the long run.

4. Protect Your Nest Egg

If you’re really worried about things like a college or retirement fund during a downturn in the market there are a few steps you can take to protect these funds.

  1. Reduce your debt. If you start losing money in the market that threatens to deplete your funds, you don’t want to have to pay creditors while trying to take care of yourself and maintain your accounts. 
  2. Ask your financial advisor about reducing the amount of risk you have. You may have overextended your comfort level after the longest bull market in history. Reducing your overall level of risk will at least make you feel more confident about your portfolio if you know that you’ll have a  portfolio that is less affected by market fluctuations moving forward.
  3. Don’t invest money you think you may need. This is especially important for retirees who may only have investment income to rely on as they get older. While it can be tempting to take advantage of stocks that have lost significant value and appear to be on sale; you should never invest funds that are needed in the short term. The average bear market has lasted 22 months, and you don't want to put those funds at risk if you need them.

5. Focus Long-Term

When you start to see headlines of the stock market declining it can be easy to go into panic mode and wait to watch values decline in real-time. However, when you sell investments in a downturn your essentially locking in your losses. When the market eventually stabilizes you'll likely be left chasing much higher prices. It's always a good idea to keep your long-term goals in mind before making any decisions in a downturn and consulting with an experienced financial advisor before making any moves.

Warren Buffet once advised to take a look at the earnings sheet to determine whether you have made a good investment, not the market. You can’t judge your investment strategy at a single point in time; you have to look long-term.