There are things which are in your control and things which are out of your control. Market returns are out of your control. Worrying about market returns is energy wasted. It is also often counter-productive.
For many investors glued to the news, the global outlook appears to be perilous with no prospects of growth for the world economy. In the midst of the current 2020 COVID Bear Market, many investors are scared as they see their portfolio values return to what they were worth at the beginning of 2019. Instead of panic, there are several actions you could take.
1. Stay in the markets.
Stay invested in the markets. Selling out of stocks after a market correction locks in losses. During a Bear Market, avoid selling to cash and avoid selling stocks to move more conservative.
There is often a steep price for panic selling. Many people exit markets that have dropped only to wait to reenter until the market is higher than where they exited. Fearful investors often experience most of the downside risk while receiving little if any of the upward recovery.
Remaining invested can be the most helpful when it is most difficult. We are biased to believe that recent occurrences will continue. When it comes to market returns, this instinct must be overcome. The markets went down. They are not going down.
This is one area where an investment advisor can add value. Even an advisor who does nothing other than help you set an asset allocation and stick to it may help you avoid the big mistake. Together, these bonuses help increase the likelihood that you will reach your retirement goals.
2. Harvest capital losses.
Capital losses are extremely valuable on your tax return even though they represent money lost to investment returns.
Obviously, no one purchases investments hoping that they will decrease in value. However, the markets are inherently volatile. Investments often go down in value, up again, down again, up and down a few more times, and then eventually stay up.
Tax-loss harvesting is the strategy of selling a position while it is down to save money on taxes. Unfortunately, if all you do is sell the holding, you might miss the investment’s recovery when it gains value again. That is why, once the losses are realized, you will want to ensure you reinvest the cash. Remaining fully invested and balanced to your asset allocation targets requires some specialized trading techniques to avoid wash sales, but there are several options.
While you can only use $3,000 per year of capital losses to reduce your taxable income, you should bank as much capital loss as possible for other future uses. While no one hopes for the market to go down, having a balanced portfolio generally means having holdings with both losses and gains. Taking advantage of harvesting losses creates a tax-efficient use for the losses that can help keep your portfolio balanced in the future.
We recommend that you harvest major capital losses whenever you have them, but remain fully invested in the markets.
It is always a good time to have a balanced portfolio. Rebalancing is the process of buying and selling assets in order to move your portfolio in alignment with its original target asset allocation. Even when you aren’t sure what you should do, rebalancing is always a good option.
Rebalancing can both boost returns and lower volatility. While capital gains are often a barrier to rebalancing that you must work around, a large downturn is a reprieve from this obstacle.
4. Set an asset allocation (if you don’t have one yet).
If you don’t have asset allocation targets, you just have a bunch of investments. Without asset allocation targets, your portfolio moves and drifts at the whim of your original purchases.
Investors should set an asset allocation where they are willing to endure that allocation’s known volatility. Having an asset allocation where you get out of the markets if they drop will not meet your goals. Getting out of the markets when stocks are down locks in those losses and is the opposite of rebalancing.
It is important to have an investment strategy where you can remain invested throughout market movements.
5. Consider your stock allocation.
Setting a top level asset allocation between stocks and bonds is the most important asset allocation decision in determining the future returns you will experience.
Some advisors recommend the same portfolio allocation of 60% appreciating stocks and 40% stable bonds no matter what the client’s specific situation. This conservative allocation does balance volatility and return nicely, but, while it may provide an interesting return, it is not tailored to meet a specific family’s financial goals.
Despite the occasional Bear Market, we believe that an overly conservative portfolio is not the best way to strive to meet your retirement goals. A conservative investment approach will be accompanied by a conservative rate of spending.
Investors in or approaching retirement should have at least five to seven years of their safe spending rate allocated to stable fixed income investments like bonds. Assets which are not needed for the next seven years can be put into appreciating equities like stocks.
If your target retirement date is age 65, we would recommend that you move into bonds by at least age 58. If you wanted to be as aggressive as possible, you could have an all-stock portfolio prior to that age.
Even when creating a very aggressive portfolio, having some fixed income investments can, at times, actually boost returns. Stable investments provide some cash on the sidelines. Having cash to buy back into stocks after a market correction both boosts as well as smooths your investment returns. Because of the effect of compounding, smoother returns produce better returns.
As a result, we generally recommend having the amount of bonds which would be appropriate to your safe spending rate if you were to retire today. This recommendation is often more aggressive than many financial advisors (who recommend 60-40 regardless), but less aggressive than the possible recommendation of an all-stock portfolio at age 57.
We use these suggested fixed income allocations by age both in our Marotta’s Gone-Fishing portfolio calculators as well as our article, “Maximum Safe Withdrawal Rates in Retirement.” By way of comparison, at age 55 they both recommend about 20.4% in bonds.
If you are age 55 and have a portfolio of 40% in bonds and 60% in stock, you could use this moment in the markets to move to what might be a better age-appropriate asset allocation of 20.4% in bonds and 79.6% in stocks.
Although moving more aggressive during a correction can be advantageous, we don’t recommend moving more conservative after a market correction.
6. Practice extreme thrift.
Financial uncertainty instinctively causes most of us to spend less. This is one of the more helpful reactions to a downturn in the markets. Moderating your spending is one of the things which is under your control and always has a large impact on your financial well-being. Investment performance is rarely the reason a retirement fails, but overspending assets always risks retirement failure. Thrift is a virtue, and learning how to spend is an important financial skill.
With more time at home and less eating out, this is a perfect time to learn to cook. You may eat healthier food and enjoy a new hobby as well as saving money over purchasing convenience foods.
7. Save and invest more.
If you are practicing extreme thrift, this is a great time to save and invest more than you have been doing. Saving and investing is possible, simple, urgent, and valuable. By age 35, you really should have saved more than twice your salary. This is a good time to check in with a financial planner and see if you are on track for your financial goals and how much you should be saving. At a minimum, strive to save more even if it is less than you should be saving.
8. Contribute more to your company retirement plan.
If you haven’t been contributing to your company retirement plan, now is a great time to start. If your employer has a safe harbor match you might get as much as 4% extra of your salary for every 5% of your salary that you save. Getting an immediate 80% return on your money overcomes any Bear Market in history.
Increasing the amount you put in your company retirement plan is an easy way to automate your retirement savings. If you have been contributing, now is a great time to increase the amount you are saving. If you invest throughout a downturn in the markets, then by the time the market is back to where it started, you will have a nice gain on your buy-low purchases.
9. Convert some of your traditional assets to Roth.
A Roth conversion is the process of moving assets from your traditional IRA into a Roth IRA. Roth IRAs are unique because the investment growth is never subject to taxation – even when the assets are distributed from the account. Roth conversions can avoid future Required Minimum Distributions (RMDs), enhance the value of your estate, and smooth your tax burden across several years.
Systematic Roth conversions, where you convert some of your IRA each year as part of a larger strategy, can be worth millions of dollars. However, even just one Roth conversion in one year can be extremely valuable.
A Bear Market represents a great time to convert for the same reason that you may have anxiety at night: Your IRA is worth less right now. And there are two simple strategies you could use to determine how much you want to convert.
10. Refinance your house
With mortgage rates at a relative low, this might be a good time to refinance your house. Families who could afford pay off their mortgages usually do better by not paying them off. Using a mortgage wisely, we recommend refinancing to a 30-year fixed mortgage with no closing costs and no buying down of points.
11. Buy a new house.
With a downturn in the markets, many potential home buyers will feel relatively poorer and housing prices in many markets may drop. If you are looking to purchase a house and have set that money aside in cash or fixed income investments, now might be a good time to find property at a discount.
12. Start a business.
You may have lost your job or you may simply have a lot of free time on your hands. Either way, you may want to consider going into business for yourself. For example, you could take a hobby that you enjoy and try to monetize it.
Becoming a business owner is like becoming a parent. There is a sense of wonder that you could be entrusted with so much responsibility and a sense of dread when faced with trials that push you to the limit. There is a fun part to the business, which is the reason you started it in the first place. Then, there is often other parts that you suffer through because they are urgent or important to the success of the business.
It is normal to worry about the stock market and what might happen to your net worth. This is especially true after retirement. Before retirement, your income supports your lifestyle. There is money left over for saving and investing. If the market drops, you continue to add to your portfolio while it recovers.
During and after retirement, it is normal to feel a great unease.
In my experience advising clients, no amount of money helps alleviate that discomfort. When your income ceases and your nest egg is a fixed amount of money. The dread of loss can feel overwhelming and cause people to want to play it safe and take as little risk as possible.
However, this anxiety gives you bad advice. Oftentimes, the opposite plan gives you the best chance of having a secure and prosperous retirement.
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