What To Do (And Not Do) During This Market Downturn

Have you looked at your 401k statement lately? If so, you might have been tempted to sell out of any stock funds you have. Don’t. You’ll likely be turning a temporary loss into a permanent one.

According to this article, here’s how long it would have taken to recover from the following downturns if you had invested $1,000 in the S&P 500 (500 of the largest stocks in the US) and continued to invest $1,000 each year (as people generally continue contributing to their 401k plans):

Great Depression                            7 years

1970s recession                              3 years

Dotcom bubble                              5 years

Great Recession                             2 years

So what are the lessons of this?

1) Only invest in stocks for long term goals. Don’t invest money you need in the next 5-7 years in stocks. (This includes cash to cover 3-12 months’ of necessary expenses in an emergency.) It’s impossible to reliably predict the next downturn in time to avoid it and your money may not recover in time.

2) Diversify. The easiest way to lose money in stocks is to not be property diversified. After all, it would essentially take the end of the world for every major company to go broke but a single company can easily go bankrupt. A good rule of thumb is to never have more than 10-15% of your portfolio in any one stock and to have a mix of sectors. You may also want to include international stocks in case the US goes through an extended period of under-performance.

3) Don’t panic and sell stocks during a downturn. If you bail out of stocks after a decline, you’ll only end up missing the recovery. That loss you see on your statement is only a temporary “paper” loss. Selling will turn it into a real one.

4) Look for tax loss harvesting opportunities. Selling a taxable investment turns that paper loss into a real loss from a tax standpoint too. One advantage of that is that you can then use it to offset any taxable gains you may have or even to reduce your ordinary taxable income by up to $3,000 a year. (Any excess losses can be carried forward indefinitely.) Be sure to reinvest that money so you can benefit from the eventual recovery but if you reinvest in the same investment within 60 days, you won’t be able to take the loss off your taxes.

5) Re-balance periodically. Another way to take advantage of a market downturn is to re-balance your portfolio back to its original allocation. For example, if your target allocation is 60% stocks and 40% bonds based on your time horizon and risk tolerance and your current allocation is now 50% stocks and 50% bonds due to the decline in stock prices, you’ll want to move enough money from bonds into stocks to bring your allocation back to the original 60/40 split. That way you’re actually buying more stocks while they’re relatively low in price. Your 401k plan may even have a feature to do that automatically.

6) Re-allocate if necessary. You may also decide that you just can’t sleep at night during these downturns. In that case, you may want to reduce what percentage you invest in stocks. (Just keep in mind that you’re also reducing your expected returns so you may need to save more or plan to have less for your goals).

7) Consider getting professional help. If you’re not sure how to re-allocate, see if you have any investment advice tools available to you or fully-diversified balanced or target date funds that allocate and re-balance for you. A recent study showed that people who took advantage of these forms of investment help earned almost 2% per year more net of fees than those who didn’t. You might also want to work with a professional advisor for more personalized advice. To minimize bias and investment fees, look for one that charges a flat hourly fee (like the Garrett Planning Network) or an annual retainer (like the Alliance of Comprehensive Planners) rather than sell investments for a commission or charge a fee that’s a percentage of the money you invest.

Market downturns can be scary and even terrifying. The bad news is that they’re practically inevitable but impossible to predict. The good news is that they’ll only be harmful to us if we let them.

 

 

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