As of this week, the Dow Jones Industrial Average (DJIA), a stock market index that tracks 30 large publicly traded companies, was down approximately 13% from its high in December 2021. The broader S&P 500 Index of 500 publicly traded companies in the U.S. was down roughly 16% over the same period and the tech heavy Nasdaq Composite Index was down approximately 26% from its 2021 market high.[i] By definition, a bear market occurs when stock prices decline by more than 20% from recent highs accompanied by negative investor sentiment and declining economic prospects over a sustained period of time – typically two months or more.[ii]
Bear markets always breed wide-spread anxiety and make sensational news media headlines. High priced technology stocks have taken the brunt of losses as day traders look for quality investments and strong balance sheets in a tighter money-supply environment. It’s hard to fight the urge to “do something” like sell stocks in an effort to cut further losses, especially when it seems like everyone else is trading! However timing the market successfully has been historically difficult, if not impossible for an extended period of time. That’s because timing the market means you need to be smarter and faster than computerized trading and professional day traders two times: first to sell before the market goes down, and a second time to buy back at the very bottom before the market recovers. Often, emotional trading results in just the opposite: selling when the market is already down, and then buying back when the market has already recovered and is “safe” again.
What the news media fails to cover is that bear markets are actually quite common in the history of the market. Since 1929, there have been 28 bear markets, which averages out to approximately one downturn every 3.3 years. The 2008 Great Recession was perhaps the hardest to stomach, as markets lost nearly 52% of their value before roaring back in one of the most furious bull markets in history. More recently, our COVID market downturn in March 2020 lasted only 33 days, the shortest in our stock market past.[iii] If we reframe our thinking to accept bear markets, instead of worrying or panicking, perhaps we can instill some logical investment strategies to capitalize on the current situation, or to quote an overused saying, turn lemons into lemonade.
For young investors who have time on their side, you should be maximizing contributions to your work sponsored retirement plans like your 401K even/especially when the market is down. If you believe in the efficiency of the market, this blip on the radar will hardly be a talking point when you retire. Why not buy when stocks are on sale?! On top of your own contributions, many employees benefit from employer matching also. Investment gains inside these retirement accounts will be sheltered from taxation and can grow exponentially over a longer investment window.
For those who have accumulated too much cash doing a lot of nothing during COVID, now may be a good time to reposition inflated cash balances earning 0.02% at the bank into the market, so long as you can withstand a lot of short-term volatility in exchange for long-term returns. However, do not put cash into the market that you will need in the near future, and certainly do not put your emergency fund savings into the stock market.
Rebalancing your investment portfolio is the systematic process of realigning the weightings (%s) of each asset class when the actual holding has drifted from the original target weighting. Rebalancing helps to ensure your portfolio stays in line with your risk tolerance, which helps you stay invested for the long haul. Rebalancing also tends to help your bottom line return. For example, say your original investment target is 60% stocks and 40% bonds. When the market goes down, the value of your stocks shrink, making the bonds a larger percentage of the overall portfolio holdings than intended. Rebalancing would mean selling some bonds to buy back the under held stock position. Some investors might feel reserved about buying more stocks in a declining market. However, the strategy of buying stocks when they are down redeems itself when the market recovers and the investment returns are positive. On the opposite end, let’s say stocks rebound triumphantly and now the increased value of equity shares results in a 75% stock and 25% bond portfolio. While it is hard to be disciplined and rebalance, selling the stocks to buy back to the target 60%-40% model is the prudent way of locking in gains before they disappear.
Tax-loss harvesting is the process of realizing a paper loss, or selling investments at a loss, and using that loss to offset capital gains from the sale of other investments at a profit. If an investor’s capital losses exceed gains, the excess can be used to offset ordinary income up to $3,000/year on your Federal tax return. Any remaining capital loss can be carried forward into future tax years.
To ensure your tax-loss is deductible, an investor cannot buy back the same or substantially identical investment position for 30 days due to the wash-sale rule. As was seen in the COVID stock market recovery, a stock market rebound can unfold quickly. An effective strategy to tax-loss harvest and not lose out on potential market recovery is to buy a replacement equity that follows a similar investment strategy but is not identical. After 31 days, you can sell the alternative holding and buy back the original investment, without losing your tax-loss deduction.
Stay Invested Stay invested, remain on course, and get better long-term returns – sounds too good to be true? Statistically, investors in a long-term diversified portfolio who stay invested are able to capture the best days of market recovery that often follow steep market declines. Missing even just a few of the best performing days in the market can significantly hamper annualized returns.[iv] A key part of successful investing is sticking with a logical investment strategy, even during tough market dips, to potentially enjoy the benefits of efficient market returns.
Investors often work with a Certified Financial Planner ™ to develop a well-planned road map to financial success that incorporates boom and bust markets as a part of good planning. A transparent investment approach can help you be better prepared to face market volatility, and may improve your ability to stick with your plan, tune out the noise, and potentially capture the long-term returns the capital markets have historically provided. If you feel you could benefit from partnering with a financial planner, ask for a free initial consultation. It never hurts to get a second opinion!
[iii] Bob Veres Insider Information