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An illustration of a bear market.

4 smart moves to consider in a down market

Sep 29, 2022 | 6 min. read

When stock prices fall, there are strategic steps you can take to overcome human nature, improve your future tax posture or better align your portfolio with your goals and risk tolerance.

There are a couple of things it’s important to understand about so-called market “corrections” (typically defined as a decline of 10 percent or more), or even more enduring bear markets (a decline of 20 percent or more) like we have experienced this year.

  • First, they are normal. Since 1950, there have been 39 S&P 500 corrections.(1) And based on data contained in the S&P Dow Jones Indices, bear markets have occurred, on average, every 56 months since 1932.
  • Second, these declines in the market tend to be much shorter than the periods of gains that typically precede and follow them. The average length of a bear market is 289 days, or about 9.6 months and the average length of a bull market is 991 days, or 2.7 years.(2)

Why is this important? Because it’s a reminder of the importance of keeping things in perspective. Over the course of your financial journey, stock prices will go up, and stock prices will go down. When they are falling, it sometimes feels like they will never rebound. But if history is any indication, stocks are likely to go up roughly three times more often than they go down.

So the question is not what you should do if stocks slump, it’s what you can do when prices fall. And contrary to what we often hear in the media, market downturns can present opportunities to take constructive steps that will better position you to benefit when stock prices ultimately rebound. Let’s take a look at some examples.

Buy low with a dollar-cost-averaging strategy

Every investor knows that the object of the game is to “buy low and sell high,” but far too many fall victim to greed and fear and practice exactly the opposite. If you’re still in the accumulation phase of your financial journey, one way to avoid falling prey to human nature is to implement a dollar cost averaging strategy by automatically investing an equal amount of money every month. When prices are low, you’ll buy more shares. When prices are high, you’ll buy fewer.

Consider a Roth conversion

If you have money invested in a traditional IRA and like the idea of moving it to a Roth IRA so that you can withdraw money tax-free in retirement or avoid required minimum distributions, the current down market could be your friend. Why? Because the presumably lower value of your traditional IRA shares means your tax bill will be lower if you move some – or all – of them to a Roth IRA. For the sake of simplification, let’s assume that the balance in your traditional IRA was $100,000 at the beginning of the year, but is now only $80,000. If you are in the 25 percent tax bracket, that means your tax bill would be $5,000 lower now than it would have been in January if you choose to do a full conversion. One quick note of caution: a Roth conversion may not be the right move for every investor, so be sure to consult with your tax professional and financial advisor before taking action.

Use losses to offset gains and reduce your taxes

This strategy involves selling stocks, mutual funds, exchange-traded funds (ETFs), and other investments carrying a loss to offset realized gains from other investments. If, for example, your Tesla stock is trading 35 percent lower than when you purchased it, you could sell it – thereby “realizing” your loss – and then use that loss to cancel out the capital gains distributed by your mutual funds. Better yet, capital losses that exceed capital gains in a year may be “carried forward” to offset gains or income of up to $3,000 in any future tax year, indefinitely, until exhausted.

To determine if you have non-tax-qualified investments that could be used for this purpose, you’ll simply need to know your cost basis – which is the total amount you have invested, plus any dividends and capital gains reinvested. If that amount is more than the current value of the account, you have a tax loss that could be harvested.

If you are considering employing this approach, it’s important to understand that the IRS follows the wash-sale rule, which states that if you sell an investment to recognize and deduct that loss for tax purposes, you cannot buy back that same asset—or another “substantially identical” asset — for at least 30 days. So, there’s nothing to keep you from buying your favorite stock back – you’ll just have to wait a month to do it.

Needless to say, this can be a complex procedure that requires ongoing record keeping. It may or may not be in your best financial interest, so it’s important to consult your tax professional and financial advisor before taking action.

Revisit your goals and risk tolerance

 How long has it been since you thoroughly reviewed your goals and tolerance for risk? Are you confident that your portfolio still accurately reflects both? If not, this might be an ideal time to check in with your financial advisor, revisit your goals and their associated time horizons, and reassess your risk tolerance. If there have been significant shifts in these factors, it may be necessary to make adjustments to the composition of your portfolio. And even if there haven’t been, your advisor can compare the current allocation of your portfolio to its intended allocation and determine whether a rebalancing of your investments is in order. If changes are warranted, particularly in your taxable accounts, this may be a timely opportunity to implement them.

Staying the course doesn’t mean doing nothing

If you have an up-to-date financial plan and a well-balanced investment portfolio, it’s entirely possible that you don’t need to take any action at this time. It’s human nature to want to “do something” when things are not going exactly as planned, but staying the course doesn’t mean doing nothing – it simply means continuing to do things that are consistent with your long-term plan.

Coaching center line.

First Command does not provide legal or tax advice, and this report does not contain any legal or tax advice. Should you require legal or tax advice specific to your situation, you should consult with an attorney or qualified tax advisor. The information provided to you herein is provided for informational purposes only, is not intended to be tax or legal advice, and should not be used for the purpose of avoiding tax-related penalties under the Internal Revenue Code.

Dollar cost averaging is the practice of investing an equal amount of money at regular intervals, regardless of market performance. The objective of this investment strategy is to reduce the average cost per share by purchasing more shares when prices are low and fewer when prices are high. While not assuring a profit or protecting against a loss, dollar cost averaging can help remove emotion from investing. But as it involves continuous investment in securities regardless of fluctuating price levels, investors should consider their financial ability to continue purchases through periods of low price levels.

Footnotes:

(1) Yardeni Research
(2) Ned Davis Research

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