There is plenty of truth behind the old Wall Street adage that “stocks take the escalator up and the elevator down”. Case in point: after powering higher through the 3rdquarter to achieve record highs in late September while posting its single best quarter since 2013, the U.S. stock market took less than four weeks to give up all of those gains.
Stock market declines are of course frustrating for all investors, as gains achieved over many months can evaporate in a matter of days or weeks. However, periodic, sudden downdrafts are a part of investing and investors should learn to expect them and resolve to pro-actively employ tactics to take advantage of them and to use them to ultimately strengthen their overall financial foundations.
Here are three things investors can do to be proactive during a stock market downturn:
Rebalance Equity Allocation
First, consider rebalancing your equity allocation to reestablish your target weighting in equities—or even take this opportunity to increase your target weighting for equities if your previous allocation was unduly conservative. For example, if you normally target holding 50% of your investment portfolio in stocks, perhaps that allocation has shrunk to 45% in the last month. Now may be a good time to invest in stocks to bring their proportion back up to 50%.
A psychological rule-of-thumb I think useful for establishing if an investor has too much in stocks is whether, after a 10% swoon, the investor is more apt to buy stocks or to sell them. Those inclined to buy probably have a suitable allocation to stocks, while those inclined to sell probably have too much in stocks. An easy, quick, and quantitative method to find out whether your portfolio matches your personal risk tolerance is to find out your personal Risk Number (which is a number between 1 and 99 reflecting your risk tolerance) and then seeing if your Risk Number corresponds to the Risk Number of your actual portfolio. If there is a greater-than 10-point difference in the two, your portfolio is out of whack and in need of attention.
To find your personal Risk Number in 5 minutes, please click here.
To watch a 2-minute video on how our risk assessment technology works, please click here.
Harvest Tax Losses
Second, use the downturn to sell stocks (or funds) you don’t like to harvest tax losses, then immediately reinvest the proceeds from those sales into other assets that you prefer that are trading at depressed prices. You can use $3,000 of realized capital losses each year to deduct against your ordinary taxable income.
Contribute to Tax-Deferred Accounts
Third and finally, invest the maximum you can in your tax-deferred accounts for tax year 2018 right now. Many people like to wait until just before their tax filing deadline, usually April 15th, to make prior-year retirement account contributions. Investors should instead consider making those contributions sooner—such as right now. This tactic can also apply to 529 college saving plans, the profits from which are not taxable if used for educational purposes. If you were planning to make a 529 contribution, consider doing it now rather than waiting. It is, of course, impossible to know if this downturn has run its course, but we do know for a fact that stock prices are roughly 10% cheaper than they were just one month ago.
The tactics in this piece are not considered to be blanket investment advice for everyone. Investors need to know their own situations and do what is right for them. We are happy to do complimentary reviews of investor portfolios and offer our thoughts. Please call - 619.435.1701 - or email for an appointment.
Please don’t hesitate to get in touch with me if you would like to discuss your portfolio or the markets.