As I am writing this, we are in the midst of the 2020 COVID Bear Market. For many investors glued to the news, the global outlook appears to be perilous with no prospects of growth for the world economy. However in the midst of remote work, social distancing, and financial uncertainty, our firm motto still remains good advice: It is always a good time to have a balanced portfolio.
Almost every portfolio will one day need to support a steady withdrawal as your savings turns into your retirement money. However, to turn your investments into money you can spend, some securities need to be sold. Every time a security is sold in a taxable account, if it is worth more at the time of sale than when you originally paid for it, the “gain” is taxable. This so-called capital gain is taxable in various tax brackets, ranging from a base of 0% to 20%.
If you wait to sell any security until the day you want to withdraw, chances are you will be forced to realize some rather large capital gains all in one year. After all, the markets trend upward and, over large time periods, double every 7 to 10 years. However, by intentionally realizing some gains each year, you can keep your taxes relatively low. When capital gains grow too wildly out of control, you need to engage in strategies for avoiding paying the capital gains tax.
However, during a down market like this one, now is your chance both to harvest capital losses as they occur and rebalance your 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. With significant losses to offset gains realized, you can take this opportunity to truly rebalance to your desired targets rather than tiptoeing around unrealized gains.
Trim what has gone up. Buy what has gone down. Wait for the market to move significantly and do it again.
While individual stocks can go bankrupt and be worthless, it is difficult to imagine any scenario where the entire large-cap sector of the United States economy goes bankrupt. It is even more impossible to imagine every large-cap sector of all the free countries of the world going bankrupt. So long as you have a diversified, well-researched investment plan, give it time.
It may be that you buy more of what has gone down and then it goes down again. The right response is to buy more of it. Even a good investment will at times drop precipitously. If you have a good reason to invest in it, then that reason doesn’t go away just because it is down right now.
Once you understand how the market works, you know the market cannot go to zero.
A market maker has a big pile of one company’s stock. When someone wants to buy stock but no one else wants to sell it, the market maker will sell them some from their pile. After a certain number of shares trade, they are allowed to move the stock price up or down based on whether someone is buying or selling. When there are more buyers than sellers, the stock price goes up. The stock price goes down when there are more sellers than buyers.
This is the true reason why stock prices go up or down. You can imagine that if the price was going down and approaching zero, it would mean you or I could take our pocket change and buy all the companies of the world. Long before that happens, Warren Buffet would wake up one morning and think that it was a great day to buy.
This is why the markets will never go to zero. The companies that make up the market are worth far too much to be valued so poorly.
During this season of panic, investors have bought so much in bonds that the bonds are relatively overvalued and investors have fled stocks so much that the stock prices are relatively undervalued. Once the fear settles and investors settle down for the long-term again, the market will settle as well.
That is another reason why now is a great time to rebalance. Sell some bonds while they are at relative price highs and buy some more stocks while they are at relative price lows.
Although right now, as we experience a Bear Market that many worry will continue downward, you might not like being invested in the markets, you and I would love to be invested during every historical 30-year time period in the markets. Not one of us, when we reviewed those returns, would want to be sitting on the sidelines.
Long-term investors have time to recover. You can do this. If you don’t want to do it alone, this might be the time to reach out for help. Feel free to drop us a message or give us a call to get started today.
Photo by Zdeněk Macháček on Unsplash