Weathering the ups and downs of the stock market can create anxiety for some investors, especially when your investment portfolio is the primary source of funding for your upcoming planned sabbatical.
But here’s the thing: we expect the market to go up and down. Most financial planning software programs use monte carlo analysis, which “bakes in” down-years in the market to create the long-term projections we base our saving and spending decisions on.
💡So instead of a down-year being a reason to be nervous or to not invest all together, let’s talk about what you can do when the market inevitably does go through a down cycle. There are 4 effective financial strategies to consider when the market is down.
Here’s the scenario:
▪️ You have some excess cash – your emergency fund is fully funded, your bills are getting paid every month, and your checking/savings account has accumulated a balance beyond what you need in the short term. You feel comfortable investing, so you put some money in the market.
▪️ It’s interesting for a while to watch the value of your investments change every day – some days it goes up a bit, then some days it comes back down a bit. But so far, you’re still up from what you originally invested.
▪️ Then it happens. The market has a “correction” and the value of your investments is breakeven at best, with some of your investments at a loss. And then the market continues to slip day after day, even if just by a little. But the trend is clear – the market is going down.
Now what?
First thing’s first, see below for the three important tenets to keep in mind when considering investing:
1. Investments can lose value.
💡 This is why it’s important to invest only as much as you’re able to do without in the short term. And by short term, we mean up to 5 years.
It’s also an important reason to make sure to match your investment risk level with your planned timeline for using the money. Shorter timeline, less risk you are likely willing to take.
2. Losses, with some exceptions, are often temporary as long as you remain invested.
History has shown that in general, the market goes up over time. And by over time, we mean 10+ years.
💡 So the general recommendation is to stay in the market, even when it’s down, and plan to ride out the bumps along the way.
3. Being optimistic that the market will consistently go up every day isn’t realistic.
The return that investors get by putting money into the market goes hand in hand with the level of risk that they’re willing to take – that’s why the return is rewarding.
💡 By investing, you are willing to weather the ups and downs of the market on a daily basis for the potential of a future investment return.
Keeping these tenets in mind can prevent you from panicking or reacting quickly to market movement. Instead, if you commit to an investor’s mindset, you can feel EMPOWERED to keep the daily ups and downs in perspective, and you can see that the market provides opportunities, both when it is up and when it is down.
What?! How can there be opportunities when the market is down? In this blog post, we will explore four financial strategies that can help you navigate a changing market landscape.
4 Effective Financial Strategies To Consider When The Market Is Down
#1: Review Expense Ratios and Fund Characteristics of Your Existing Holdings:
Account Type: Specifically after-tax brokerage accounts, but can apply to retirement accounts as well
When returns are lower (or negative), it can be a good time to review your overall portfolio and make sure you’re well positioned for a market rebound, whenever that happens in the future.
Here are some areas to consider:
Risk-appropriate diversification
Diversification is key when it comes to investing. We never know which part of the market will do better than the others in any given year. So having exposure across the different markets – aka asset classes (big companies, small companies, real estate, international, etc) – spreads out the downside risk, while at the same time, giving you the opportunity for a portion of your portfolio to benefit from the better performers that year.
Rebalancing your portfolio on a regular cadence can also help you maintain an appropriate level of risk. By rebalancing your portfolio back to your target portfolio, you essentially follow the “buy low, sell high” strategy. Rebalancing during a down market means that you sell the better-performing investments (the winners) to buy the undervalued investments (the losers, if you will) at a discounted price so that when the market does rebound, you have more shares that will experience the upside.
Don’t know how to appropriately diversify or rebalance your portfolio? No worries – you can pick a target date fund that matches your time horizon (when you think you’ll start using the money), and the fund managers take care of the risk-appropriate diversification and rebalancing for you. So, for example, if you’re 39 years old now and plan to draw from your retirement account at age 67, you can pick a target date fund that is about 30 years out from now. Or, say, you want to use the money to fund your sabbatical in 10 years – pick a target date fund that is 10 years out from this year.
Optimize asset location for tax efficiency and time horizon
For our investment management clients, part of our trading practice generally includes investing the more conservative asset classes in the accounts that the client plans to tap first, and the “riskier” asset classes in accounts that will be tapped last.
More often than not, the last account to tap is Roth money, since Roths are the most tax-advantaged account types (they grow tax-free and the money is not taxed at distribution). So you will often see us put the more aggressive investments in the Roth accounts so they have more time to rebound from the short-term market ups and downs. This can also lessen the emotional impact of a down market because your short-term goals can be funded using the more conservative investments.
Underlying expense ratios and general fund characteristics
The investment landscape has changed a lot over the last few decades. Technology has allowed fund managers to be more efficient in their work, which means that the cost of managing a fund can now be much lower too.
It’s up to the consumer-investor to know whether they’re paying front-end loads, transaction fees, and to understand the underlying expense ratios and taxation of the investment vehicles inside their investment portfolio. Morningstar reports can be a helpful tool.
Generally speaking, exchange-traded funds (ETFs) are more tax-efficient than mutual funds because they have fewer mandated taxable events than mutual funds do. This makes them especially good investment vehicles for after-tax investment accounts, which are subject to capital gains.
Learn more about the difference between ETFs and mutual funds here.
The goal, particularly in a down market, is to keep fees as low and reasonable as possible since fees eat into your overall investment return.
If you have an investment manager managing your portfolio for you, pay special attention to the “fees” line item on the reports they send you. And ask about how they handle transaction costs and expense ratios within the funds that they are purchasing for you. Also, ask whether the performance number you see on your report is a gross-of-fees or net-of-fees number. The net-of-fees number is the really important one – it tells you how much of the investment gain you actually get to keep in your pocket or reinvest for future growth.
#2: Tax Loss Harvesting:
Account Type: After-tax brokerage accounts (does not apply to retirement accounts)
Look for short-term capital losses to offset capital gains generated as part of rebalancing.
For our investment management clients, part of our trading practice generally includes minimizing the tax impact of our trades when possible, while still keeping the portfolio at the appropriate risk level.
Taking advantage of losses in a down market can help move your after-tax investment accounts closer to your target portfolio, while generating relatively lower taxable capital gains.
For example, sometimes a down market provides a unique opportunity to take some capital gains on a highly appreciated position that you would otherwise deem a “non-seller,” and using losses from your other investments to mitigate the tax consequence of making that sale.
This may result in more trades than you would typically generate when the market is up.
Learn more about the tax loss harvesting strategy here
#3: Roth Conversions:
Account Type: Traditional IRA, preferably with enough in after-tax savings to cover the associated tax of the conversion
When the market is down, this is a good time to consider Roth conversions. A Roth conversion involves moving funds from a pre-tax IRA to a tax-free Roth IRA. This strategy is especially attractive when market prices are lower, as it allows you to convert more shares for the same tax impact.
By moving investments in-kind (i.e. as shares of current investment holdings, rather than as cash), you can take advantage of the lower share prices, potentially enhancing the tax efficiency of your portfolio.
CAUTION: If you withhold tax as part of the Roth conversion and you are under age 59.5, the withheld amount is not only subject to federal and state income tax, it is also subject to a 10% early withdrawal penalty. So we generally recommend withholding 0% tax on the conversion itself, and pay the tax due from your savings account.
Learn more about Roth conversion considerations here
Even if you are in a higher tax bracket now, it may still make sense to convert a portion of your IRA money to your Roth IRA in a down market. Why?
- It opens up the opportunity to use the backdoor Roth strategy if you are above the income threshold to make a direct Roth contribution
- You may have pre-tax retirement account balances that are quite high, and your future distributions from those account types could push you into a higher tax rate
- Looking even further into the future, your pre-tax account beneficiaries could be negatively impacted by the taxable income from the required distributions that apply to inherited accounts.
Learn about different ways you can get your retirement savings into a Roth account here.
#4: Invest Excess Savings:
Account Type: This can apply to all account types. In general, if you’re able to save more, it’s a positive thing.
The age-old adage of “buy low, sell high” holds true in a down market. A down market is a great time to invest excess cash. It means you’re buying at a discount!
If you’re still working and contributing to your company’s 401(k) plan, you may want to consider increasing your contribution rate if your cash flow allows. With each extra dollar that goes in, you buy more shares that, as long as you’re committed to staying invested for the long term, will likely have a positive compounding effect on your overall portfolio as you head toward retirement.
Want to get the biggest bang for your buck?
Consider the different ways to get that cash into a Roth account, even if you’re a high-income earner.
Summary: What to do when the market is down
In an ever-changing market, it’s key to find the opportunities where they are. By implementing these four financial strategies above during a down market, you can make moves that can help optimize your investment portfolio for long-term growth.
Remember: focus on managing expenses, minimizing tax liabilities, and taking advantage of the market’s discounted prices by getting new money in when the buying is low.
📉📈Market fluctuations are a natural part of the investment journey. As financial planners, our goal is to help you to stop fearing the ups & downs of the market and use them instead to fund your wildest dreams. A better understanding of the market, as well as a well-thought-out strategy, truly allows you to not only turn challenging times into opportunities for financial success, but also embrace the changes with peace of mind and confidence. Contact us for personalized advice.
Let’s get you on the road to financial empowerment!
About Us
Not your typical financial planners…
We both had amazing and memorable sabbatical experiences earlier on in our careers (if you’re curious you can learn more here). Our time abroad shaped the humans we are today as well as the business we are building!
As financial planners, we now help you get that experience too!
Our mission is to make sabbatical breaks not only possible but also an important, intentional, and rich part of your career through smart financial planning!
Once you’ve committed to taking a sabbatical and have an idea of what you want it to look like, contact us! We can help you to better understand your current financial situation and what it would take to make your sabbatical dream a reality.
With smart planning, you really can have it all!
Kailie & Taylor
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