TRAILER

Welcome to episode 76 of the One for the Money podcast. I am both glad and grateful you have taken the time to listen. In this episode I’ll share how you can use a drop in the stock market to your advantage.

In the tips, tricks, and strategies portion I will share a tip regarding year end planning strategies.

In this episode...

Opportunities in Down Markets [0:59]
Investment Strategies During Market Declines [2:55]
The Historical Behavior of the Stock Market [11:10]

MAIN

Better Planning Leads to a Better Life, and that can especially be the case in down markets. Many people fear stock market downturns but hopefully at the end of this episode you are able to see the silver linings amongst the rain clouds. In fact that reminds me of a fantastic quote by one of the worlds most famous investors, Mr. Warren Buffett.

He said and I quote ““Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble.”

This speaks to the tremendous opportunities that a down market can present, but you have to have the stomach to handle them. During such times it’s easy to get gripped by fear and I don’t blame people as losses are incredibly hard to stomach. In fact losses are twice as impactful for investors than equivalent gains. Studies have shown that a 10% loss hurts twice as much as a 10% gain. I know this from personal experience when very early in my time as an investor, I purchased a stock which then dropped 50%. I sold out only for the stock since that time to increase over 7,900%. that’s right, instead of selling I should have bought more and enjoyed a nearly 8 thousand percent gain. For more details on this painful lesson see episode 18 of this podcast entitled, when life gives you lemons, stay invested.

With a pessimistic mindset, you can make really poor decisions and miss incredibly once-in-a-generation type of opportunities, like I did, but with the right mindset you can see the economic rain storms and instead of running for cover you grab a bucket as Warrant Buffett said so well. And when you employ these better investment strategies it will make for an even better life.

Here are the strategies to consider based on how far down the market is. I’ll use each calendar year, January 1st, as the starting point.

Here is what one should do when the stock markets are down 5%.

If the stock markets are down 5% from where there were on January 1st, there really is nothing one should do other than stay the course. Drops in this magnitude are far more typical than one might imagine. In fact in the last 44 years, the stock market has been down on average 14.2% at some point during the calendar year. So at one point between January 1st and December 31st of every year since 1980, the stock market was down around 14% on average and yet, 33 of those 44 years, the markets ended up higher on December 31st than where it had started on New years day.

Most times the best thing you can do is nothing at all.

Here is what one should do when the stock markets are down 10% , the definition of a correction.

Your first option is to do nothing and stay the course but there are also some ways to take advantage of these likely temporarily lower prices.

The first consideration is to rebalance your accounts. For example, let’s say you have identified a portfolio of 80% stocks and 20% bonds to be your ideal portfolio to help achieve your goals. Now let’s also say there is a drop in the stock market of ~10% and this causes the stock holdings to go down to 70% from 80%. Alternatively the bonds portion of your portfolio rises by from 20% to 30% in this hypothetical example. Rebalancing merely, shifts your portfolio back to it’s initial distribution, so 10% of bonds or bond funds are sold and 10% stock funds are purchased to get back to your original ratio of 80% to stocks and 20% to bonds. This enables you to buy stocks while they are lower priced. This was a huge win for my clients during the Covid crash because I rebalance client accounts on a quarterly basis. We were fortunate in the market low just happened to occur on March 23rd. Stocks had crashed as much as 34% on that date and so when clients accounts were rebalanced on March 30, they were able to purchase stock at these very low prices. In fact stocks, represented by the S&P500 were up 50% at the end of 2020 from the low point on March 23rd, 2020.

Other strategies you can consider when markets are down 10% that are specific to retirement accounts are as follows. You could accelerate retirement plan contributions. Instead of spreading contributions over the year, you could increase those contributions when markets are down 10%. Of course the stock market could go down further so you could also keep your recurring contributions as they are. However, one additional consideration is to initiate partial Roth conversions.

Roth conversions work just as they sound, you convert portions of your not-yet-taxed retirement accounts to never again taxed accounts. There are no income limitations but since you will be paying income taxes in the year of the conversion it makes the most sense to complete Roth conversions in the years when your income is lower. For example if you work part time in the years prior to full retirement that would be a great time to consider Roth Conversions.There are many factors to consider so be sure to speak with the right CFP.

For those with Non-Retirement Accounts you can consider Tax Loss Harvesting. That’s where you sell investments with gains to offset those with losses. For example, let’s say you purchased stock ABC for $5000 and it’s now worth $10,000. Let’s say you also purchased stock DEF for $7500 and it’s now worth $5000. You could sell both stocks and the $5000 gain in ABC would be offset by the $2500 loss in DEF so you’d only be taxed on $2500. Please note, that you have to wait more than 30 calendar days before you purchase stock DEF otherwise it would negate the offset due to wash sale rules.

I usually conduct tax loss harvesting in the fall each year and occasionally during the year if conditions allow for it.

What strategies should one consider if stock markets are down 20% or more, which is the definition of a bear market.

Generally they are the same strategies you would consider when the stock market was down 10%. If the stock market was down 20% from where it was on January 1st again you will want to definitely consider Rebalancing to increase your exposure to stocks. In retirement accounts it’s straight forward as there are no taxable implications but with non-retirement accounts those need to be considered. Also regarding retirement Accounts you will want to further expedite Roth Conversions and/or accelerate retirement account contributions (Roth or Traditional). Again for those with Non-Retirement Accounts you will want to consider tax Loss Harvesting.

And for those that are already retired, you will want to assess if you need to make adjustments to your income distributions and only take distributions from dedicated income sources (ie conservative investments). We implement income guardrails for our clients and adjust their income lower or higher based on market events. Clients are often surprised how much their investments drop before they would have a drop in their income.

What if stock markets are down 30%, One of those rare moments when it can rain gold.

If markets are Down 30%, this may surprise you but it really is more of the same. Rebalance your stock and bond ratio to increase your exposure to stocks. With Retirement Accounts - Expedite Roth Conversions &/or Contributions and with Non-Retirement Accounts - Tax Loss Harvesting. For those that are Retired take distributions from dedicated income sources and Confirm one hasn’t hit your Income Guardrails.

All of this of course is easier said than done. When markets drop, especially when they do so steeply it can be a challenging time. For this reason one should always invest according to ones goals and in alignment with time-tested investment principles but that shouldn’t prevent you from taking advantage of when the market provides opportunities. As Warren Buffett also said, when people are greedy get fearful but when people are fearful get greedy or better yet, get planning for a better life.

This is a way better option than the alternative, which is selling your stocks.

The last few years have offered more than enough unprecedented events, the stock market included. Back in 2020, with the global pandemic shutting the world down we had the fastest bear market which is more than a 20%, it just took 16 days for that to happen and then dropped further still. But only a short time later the stock market rocketed higher with the fastest 50 day rally in history, and later still with one of the fastest 100 day rallies in history.

But it was those that reacted to the losses that really were impacted financially. Fidelity manages over $4 trillion dollars and they found that close to one-third of their investors over the age of 65 sold all of their stocks during the Coronavirus meltdown*. Unfortunately because they sold, their investments missed out on these significant rallies to the upside. Here’s a great quote from the WSJ article at that time “people tend to sell after an economic downturn is already priced into equity markets, By selling at this time, investors are locking in their losses”

Maybe these facts regarding stocks will be helpful to people to take advantage of stock market downturns:

Over the...