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The Market Just Dropped 20 Percent (or More): What Should I Do?

Well, it’s been a bumpy ride.  Actually, not even as bumpy as we’d like.  More like a free-fall on some days.  The S&P 500 has dropped 25+ percent within the last 4 weeks, and it’s not clear when we will hit the bottom of the trough.  Of course, the greatest concern on everyone’s mind is how to stay safe and healthy during the coronavirus pandemic.  However, many investors can’t help wondering in a spare moment— what, if anything, should we do in light of the recent market decline?  

Several articles in the financial press have advocated that investors “do nothing.”  And, to be sure, doing nothing is far better than doing something… if it’s the wrong something. The current level of market volatility and the uncertain economic outlook increase the possibility of adverse consequences if investors make changes without the help of a trusted advisor.  However, for those with the knowledge and expertise to take advantage of it, the recent market dip does present opportunities, depending on an individual’s situation, risk tolerance, and assets.  

Buying Stocks “On Sale.”  The first and most obvious opportunity is that, for those with assets to invest for the long-term, this could be a great time to “buy low” in the hopes of “selling high” down the road.  If you have significant bond investments, this could be a good time to rebalance and move a portion from bonds into stocks.  Similarly, if you have idle cash in banks to invest in a taxable account, if you make annual contributions to a Roth or traditional IRA, if you have a high cash balance in an HSA, this could be a good time to move funds into the stock market. 

When would this be a BAD idea?  

  1. If you are trying to time the market.  Last Thursday seemed to be a fantastic day to invest.  So, did last Monday… along with several other days earlier in March.  Investors are notoriously bad at trying to time the market— and professionals are not much better.  That is why we at PFS do not attempt to do so.  Instead, we rely on a target allocation for client portfolios, based on their personal risk tolerance and financial situation.  This allocation tells us how much to move into the stock market, assuming it’s appropriate for your circumstances.  For example, a client may have a target allocation of 60% in stocks and 40% in cash and bonds.  If their portfolio was in balance as of mid-February, after the market decline of the past 4 weeks, the portfolio would now have approximately 55% in stocks and 45% in cash and bonds.  So, we should move enough cash or bonds into equity funds to return to a 60-40 allocation.  This is a disciplined and strategic way of taking advantage of market volatility on the margins of a portfolio, without trying to guess exactly when the market will hit its highs and lows.  However, since our crystal balls refuse to tell us exactly when the market will recover, we may be more or less aggressive in rebalancing to a client’s target allocation, depending on the client’s personal circumstances (see below).
  2. If you need the money.  If your job may be at risk in the current economic environment, if you need cash for upcoming expenses such as a new car or tuition payments, if you’re on the brink of retirement or are in retirement, if you may need to tap your HSA for out-of-pocket medical expenses, this may not be a good time to move funds into the stock market.  Again, no one knows when the market will bounce back.  Make sure that any money going into equities can stay there for the long-term. 
  3. If you won’t be able to stomach continued volatility.  Even if you don’t need assets in the near-term, will you be able to watch your equity investments drop another 10% or 20% in value without panicking and selling them?  If you move funds into the stock market only to face increased anxiety and sell out of the market after another significant decline, you would be better off doing nothing.
  4. If you don’t know what investments to buy.  If you’re considering investing in the market but don’t have a clear idea of what you would purchase and why, seek the help of a trusted adviser before taking action.  At PFS, we avoid buying individual stocks and use only well-diversified, low-cost, passively-managed investments.  We also try to capitalize on the relative performance of different asset classes—e.g., if you think U.S. large company stocks are on sale, check out U.S. small value stocks!

Harvesting Tax Losses.  If you have purchased stock funds in a taxable account within the past couple years, you may be able to realize capital losses in your investments, which would help reduce your taxes this year and possibly for years to come.  

When would this be a BAD idea?  

  1. If you are unsure how to buy back similar securities in the same or another account.  Harvesting losses requires selling investments when they’re down, and due to wash sale rules, the IRS will not allow you to turn around and buy the exact same investments immediately thereafter.  On the surface, this seems to be doing the exact opposite of the “buy low, sell high” mantra for investment success.  You can buy back similar investments, however, in the same or a different account within your portfolio.  This will allow you to harvest the tax losses without locking in a loss in your investment returns.  Note that this strategy will likely result in larger taxable gains in the future.
  2. If you are unable to buy similar securities on the same day.  With one-day market swings of 5% to 10% occurring with some regularity over the past few weeks, you could lose significant value by selling investments one day and buying similar ones the next day.  Ideally, any purchases of similar securities would take place on the same day as the sales to harvest tax losses.

Roth Conversions.  If your current tax bracket is relatively low and you were planning to convert funds from an IRA to a Roth IRA this year, now would be a good time to do it.  You can convert the same number of shares for a much lower price than a month ago, and hopefully, by the time you use the Roth assets, the coronavirus will be a distant memory.  (Of course, prices may drop further over the coming weeks or months, so it is impossible to say whether this would be the “perfect” time to do a Roth conversion this year.)

When would this be a BAD idea?  

  1. If you are not in a low tax bracket.  Roth conversions add to your taxable income, so they should only be undertaken thoughtfully during periods of time that you have relatively low income.  See our blog on building Roth portfolios for more details.

The bottom line is that while the recent market decline presents some investment opportunities, the consequences of making a wrong move could be severe, especially with such high market volatility and the possibility of the pandemic impacting jobs and income over the coming months.  If you do not have expertise and/or professional help for financial planning and investment advice, doing nothing may be your best bet.  For PFS clients or those seeking help, please feel free to reach out any time as we navigate these murky waters together.

     
 

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