Stock market corrections are never comfortable. Unfortunately, they’re also not very rare either. In fact, the market has historically averaged a dip of about 14% at some point during each year.
Of course, there are some years, like last year (2017), when the market is so quite it seems like there’s little risk to investing in stocks a tall. But the recent volatility we’ve experienced is nothing outside the norm.
While the media always manages to come up with doomsday scenarios to explain the fall in stock prices, the reality is, long-term investors need not worry about such short-term volatility. Instead of hitting the panic button, here are 5 productive things you can do during times like these:
Rebalance your portfolio
During periods of large market swings (our current swing may not even fall into this category yet) one of the most productive thing a long-term investor can do is rebalance their portfolio back to their long-term target. For example, if your target portfolio is made up of 60% stocks and 40% bonds, but due to a market drop, your portfolio now looks like 55% stocks and 45% bonds, then rebalancing just means selling 5% of your bonds, and buying stocks with the proceeds.
If you are adding to or withdrawing from your portfolio on a regular basis, you can use the cash flows to accomplish the same strategy, i.e. during a market correction, buy stocks with new contributions or sell bonds for withdrawals.
In effect, you are forcing yourself to buy low and sell high, even though your fight or flight instincts might be telling you to do the opposite.
By sticking to a disciplined rebalancing plan, you can avoid the low-odds game of trying to second guess the market and time it just right. Unless you have a crystal ball, this rebalancing approach is much more likely to give you a good long-term outcome than market timing.
Roth Conversions
A Roth conversion transfers money from a Traditional IRA to a Roth IRA. Because the money in a Traditional IRA is pre-tax (meaning you haven’t paid taxes on it yet) you must pay taxes on the amount transferred to your Roth.
This strategy can make sense during a down market because you are paying taxes when the investment is at a lower value and moving it to an account that will be tax-free going forward.
Let me give an example to illustrate the concept. Let’s say you start with $100,000 in an IRA as of January 1 of 20XX. By December 1, the market has completely fallen apart, and your IRA is now only worth $50,000. While you don’t know what the market will do going forward, you do know that your account, and therefore your potential tax liability, are currently half of what they were at the beginning of the year. Let’s say you do a Roth conversion now and you’re in a 25% tax bracket. You will pay $12,500 in taxes. But now with the balance in a Roth IRA, any growth you achieve going forward will be tax-free.
If instead you leave the money in the IRA, and by the time you retire and withdraw the funds they have grown back to $100,000, you will owe $25,000 in taxes (assuming the same 25% tax rate).
Of course, your specific situation will determine whether this strategy actually makes sense for you, but a significant market correction can be a good time to consider converting money to a Roth.
Tax-loss harvest
Another tax strategy to think about is tax-loss harvesting. Tax-loss harvesting simply means selling investments that are worth less than what you paid for them in order to realize a loss for tax purposes.
For example, if you invested in ABC stock when it was worth $100/share 6 months ago, but now it is only worth $50/share, you can sell those shares for a loss. This loss can offset other gains you’ve had during the year, and sometimes can even offset ordinary income.
One thing to be careful of when tax-loss harvesting is wash sales. The IRS does not allow you to sell a stock to capture a loss and then turn around and buy it the next day. You must wait at least 30 days.
The same rule applies to mutual funds. However, you can often find similar, but not identical, mutual funds to replace funds you sold at a loss.
*Make sure to consult with your accountant before executing any tax strategies.
Revisit your long-term plan
Losing 5%, 10%, 15% or more of your portfolio in a short amount of time can be extremely unnerving, especially if you are in or approaching retirement. However, one thing I always reiterate with my clients is that they have a plan in place, and that plan does not depend on avoiding every market correction.
With a proper retirement plan and withdrawal strategy in place, a 10% decline in a portfolio likely doesn’t merit any adjustments at all. These sorts of corrections are part of investing. You will have years where your portfolio is up 20% (like last year for many investors) and then you’ll have years where your portfolio is flat or even down 10%.
What matters to long-term investors is not the year-to-year ups and downs, but the long-term trend. If you feel nervous about how much you’ve lost over the past few months, revisit your long-term plan and see how it looks. I think you may be surprised to see that your chances of long-term success have barely budged.
Turn off the news
After you’ve considered the above, the last productive thing to do is to turn off the TV or phone or whatever you use to consume financial news. Of course, being informed on the news of the day is not a bad thing. But the financial news rarely gives you anything of value. The media makes its money by selling ad space. The more eyeballs they can get, the more money they make. And the way they attract eyeballs is with the most dramatic and sensational stories possible.
This isn’t helpful to anyone. It just feeds on the fear we are already feeling.
As Steve Forbes put it: “You make more money selling advice than following it. It’s one of the things we count on in the magazine business – along with the short memory of our readers.”
Don’t let the financial media manipulate your emotions and push you to make a change to your well-thought-out plan. Trust that markets are doing what they do best – incorporating new information into stock prices. If you are seeing something on the news, it’s too late to act on it anyway. It’s already been built into market prices.
Conclusion
The reality is, investing involves risk. If you hope to benefit from taking those risks, then staying disciplined is a must.
If you’d like help structuring a long-term plan so you can feel more confident during market turmoil or if you’d like help implementing any of the strategies described in this article, you can schedule a complimentary, no-obligation introduction. Just click here.