As COVID-19 continues to run its course, it gives us another chance to learn from the past and prepare for the future. Yes, that could refer to a lot of things, but let’s assume it is the stock market. March was terrifying if you were an investor. Not only were we terrified to go outside during a pandemic, we also had to watch the stock market move at thousands of point clips daily.
When the market experiences prolonged price declines, it’s referred to as a bear market. Bear markets signify a drop of at least 20% from its recent high — not exactly what we like to see. It’s important to understand that a bear market is not a recession. A recession is a slowdown of economic output that is measured by gross domestic product over two consecutive quarters. While bear markets can often lead to recessions, they don’t always. Recessions deal with the economy and bear markets deal with stock markets. Remember that the stock market is not the economy — these terms are often used interchangeably and they shouldn’t be.
It’s normal to feel anxious about the market and its future — you’ve put a lot of time, research and money to see your investments succeed. Here are some actionable items you can do now to ease your fears about the stock market’s future. While things have stabilized well since March, I can promise you (unfortunately) that we will see that volatility again in the future. With that in mind, here are five things you can do to prepare for any tough times ahead.
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1. Do absolutely nothing
Though seemingly counterintuitive, doing nothing can often be the best course of action in a market downturn. Don’t look at your 401(k). Don’t look at your statement. Don’t watch the financial news. Just don’t do anything.
When the numbers start plummeting, panicking is not the answer — even though it may seem like the obvious choice. Sit tight, and above all else, don’t make an emotional decision. Eventually, the market will recover and you can re-evaluate your investments and decide on the best course of action for any future downturns.
Remember that with investing, you are playing the long game, and the more time that your investments are in the market, the greater the chance of a return will be.
Plan ahead and create an Investment Policy Statement.
2. Explore tax-loss harvesting
Tax-loss harvesting, also referred to as tax-loss selling, is the selling of securities or assets at a loss in order to offset a tax liability either in the form of capital gains or ordinary income.
The sold security or asset is later replaced by a similar, but not identical, one. A similar security might be one that targets the same industry but in a different way, like a different mutual fund or ETF. The IRS doesn’t allow you to sell a security at a loss and then buy it again a few days later: That’s called a wash sale. It’s important that you make an intentional strategy around how tax-loss harvesting will affect your portfolio.
In a bear market, tax-loss harvesting can be a great strategy for reducing taxes. Even though tax-loss harvesting doesn’t usually keep you in the position you were in originally, it can dramatically lessen the severity of potential losses. Using this strategy can save you from future tax burdens.
3. Re-evaluate your risk tolerance and asset allocation
In a down market, it’s a great time to understand how your risk tolerance and risk capacity have shifted. When you first created your investment plan, you and your financial adviser started by estimating your risk tolerance. Typically, younger folks tend to go for higher-risk investments, because their money still has decades in the market versus those who are older and are focusing on creating stable income, not necessarily high growth. Either way, risk is the name of the game when it comes to investing.
Find out the answers to the following questions when re-evaluating your risk tolerance:
- Do you need to reassess your allocation strategy?
- How has this downturn impacted your long-term goals?
- What needs to shift in order for you to still reach your goals?
A bear market is a great time to see if you estimated your risk tolerance correctly. If you estimated too high or too low, you can simply adjust and be better prepared for the future.
4. Slow or stop your withdrawals
A down market is also a great time to evaluate your withdrawal and contribution strategy. It may be counterintuitive, but bear markets are actually a good time to start putting more money in the market versus withdrawing. You can buy great investments with high potential returns at a lower price.
If you’re not comfortable putting money into the market, at least stop withdrawing money to give your portfolio and investments some time to recover. It will not happen overnight — be patient.
5. Understand market history
Education is the antidote to anxiety. The more you can learn about the stock market, its trends and history, the more you will be able to make better-informed decisions about your own holdings. Odds are, this particular bear market is not much different than its predecessors, so you just have to trust the process.
Within your investment plan, you or your financial adviser has (or should have) already accounted for down markets and will help guide you through them. Take a breath, stop withdrawing all of your investments, and follow the plan.
Risk is an unfortunate reality of investing. The market can be frustratingly unpredictable, and when the market does drop, keep these tips in mind when considering adjusting your investment strategy.
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