Since World War II, the US has experienced 12 bear markets (20% or greater drop from its most recent high). These bear markets were brought on by myriad events, ranging from wars to oil embargos to “bubbles” bursting. During each downturn, the media captivates us with frightening headlines. As we experience such downturns, it’s normal to feel anxious and worried as jobs are lost and markets decline. After all, we’re wired with a “fight or flight” mechanism that’s hard to combat. Our instincts are to run from something we don’t quite understand or feel powerless to fight, for reasons of self-preservation. When it comes to our 401(k) plans, IRAs and investment accounts, we feel this “pain” via negative numbers and losses. It’s no wonder our instincts begin telling us, “maybe this time is different and I should get out.”
When it comes to this bear market we’re experiencing today, it’s easy to describe it as unprecedented. After all, this is the sharpest and fastest bear market we’ve ever experienced in the US. Entire states shutting down schools and asking all citizens to work from home is fairly extraordinary. However, such as description could be used for most, if not all, of the last 12 bear markets as they played out. The bear markets of 2000-2002 and 2008-2009 were extraordinary too. Regardless of the severity or reason behind these cycles, the markets have recovered each time. As we work together as a country to make it through this challenging time, below are five strategies you may consider to help keep your finances in order amid this volatility.
1. Remember Newton – Yes, Sir Isaac Newton, the guy we all learned about in school. Newton was a mathematician, astronomer and physicist. He’s credited with discovering a formula for gravity, creating the first laws of motion, inventing the reflecting telescope, and creating calculus. In other words, he’s the kind of friend you would bring to a trivia night. As told in Benjamin Graham’s book, The Intelligent Investor, Newton decided to invest in a publicly-traded stock called South Sea Company. It quickly became a popular stock and Newton sold his shares for a profit of about 100%. As intelligent as he was, Newton saw this stock climb higher and higher and decided to invest once again, being swept-up in the enthusiasm over South Sea Company. Sadly, the stock later crashed and Newton lost a significant sum, amounting to millions in today’s dollars. This story is appropriate because we all feel the natural forces of fear and greed. It doesn’t matter how smart we are. The bear market we’re experiencing today may tug on those feelings, but if you were confident in your financial plan just a few months ago, stick to your plan as long as your goals haven’t changed.
2. Rebalancing – The old adage of “buy low and sell high” sounds simple enough, but what do you do in a downturn when your assets are already invested? Let’s say you had a diversified portfolio comprised primarily of stock and bonds with a 50/50 mix. Now let’s assume the stock portion drops by 20% in value. Your portfolio’s allocation has changed in this scenario and may now be 40% stock and 60% bond. By using rebalancing, you may decide to sell 10% of your portfolio that’s invested in bonds and buy stock with it instead. This example allows you to buy stock while it’s “down” by using bonds which may not have changed in value much at all. This will also allow your portfolio to come back to the original balance of 50/50 you wanted. As the markets recover, you can also go the other direction by selling stocks to buy bonds. Keep in mind, this simple example becomes much more complex when you have investments in many different places, such as old 401(k) plans and investment accounts with various firms. Professionals have the tools and experience to make this easier so you can take advantage of strategies like this.
3. Tax Loss Harvesting – When you sell non-IRA investment at a gain, you generally owe taxes on that gain. When you sell non-IRA investments at a loss, you can generally offset those losses with gains you may have somewhere in your portfolio. Downturns provide a unique opportunity to intentionally realize a tax loss to offset gains in the current year or future years. For example, if you bought $50,000 worth of Pepsi stock and it’s now worth $30,000, you have an unrealized loss of $20,000. Therefore, if you sell Pepsi and buy Coca-Cola instead, you still own a large American beverage brand and you realized a loss of $20,000 that can be used to offset taxable gains. If Coke increases in value from $30,000 to $50,000, you obviously have a taxable gain, but only when you sell it and realize the gain. This could potentially be years into the future.
4. Roth IRA Conversions – If you have pre-tax retirement assets, you’re likely deferring the payment of taxes on your savings and gains until a later date, such as retirement. The 401(k) plan was created primarily for this reason. However, you may be able to convert some or all of your pre-tax retirement dollars into tax-free Roth dollars. Some 401(k) plans allow this, but it’s largely a strategy for IRAs. Converting IRA dollars to Roth IRA dollars is complex and requires a conversation with a financial planner or CPA first, but if done correctly, this strategy can create tax-free wealth for your retirement. The reason you may consider this strategy now is due to the lower price per share of many stocks. Take the Pepsi example above. If your IRA was 100% invested in Pepsi stock (not something I would recommend), and your IRA dropped from $50,000 to $30,000, if you performed the Roth IRA conversion at the lower value, you would be paying less tax. In other words, you would own the same number of shares, but you would be paying tax on $30,000 instead of $50,000. If a Roth IRA conversion makes sense for your situation, doing so in a downturn can be wise timing.
5. Cash is King – I’ve heard many people say, “I wish I would have bought in while the market was down” after a bear market has passed. It’s easy to say with hindsight. However, during a market downturn when bad news is abound, it can take nerves of steel to invest your hard-earned cash into the markets. With that said, if you have cash that’s separate from your emergency fund, you may consider buying into the markets using a disciplined strategy called Dollar Cost Averaging. DCA involves investing a portion of your cash at various increments of time. For example, if you recently sold a piece of property or received an inheritance, you may consider investing that cash in equal amounts each month over the course of six to twelve months. By doing so, you may invest at various levels of the markets and decrease the risk of investing everything at once, just before another drop. You may also miss out on upswings by investing over a period of months, but if you’re investing for the long-term, this is a viable strategy to consider. However, if you’ve lost your job or work in an industry where your job is at risk, hang onto your cash. Only invest if it’s money you won’t need for five years or more.
Above all, remember that we’re in this bear market together. If you decide to use a strategy that benefits you financially, consider helping a charity that may be struggling financially or tip someone a bit more that may have been out of work for a while. No matter the disaster that causes our economy to contract, we can all chip in to overcome it together.
About the authors: Travis Freeman, Danton Troyer and Gus Gast are independent financial planners with Moneta. They serve successful business executives and professional athletes with complex financial, tax and estate planning needs. Questions may be directed to TFreeman@MonetaGroup.com
Please speak with a qualified tax or financial professional before making any changes to your personal situation. This article is for informational purposes only and should not be construed as advice. Past performance is not a guarantee of future results.
