Reflections

Actions to Take in Falling Markets

It is a stressful time in many ways.  Markets are down, prices are up for things you need to buy, talk of recession is looming.  It is understandable if you are stressed out about what is happening right now in your portfolio, but there is a better mindset that can keep you from making any big mistakes.

We want to focus on what we can control and not let ourselves be distracted by things we cannot.  We know many investors feel a powerful drive to do something in response to a bear market, as they should. But most commonly when markets are down sharply, the action desired is to sell stocks. While this creates a sense of control that can make people feel better in the moment, most often in these situations it is exactly the wrong thing to do at that time.

Market timing, while tempting, involves getting two nearly impossible decisions right: when to sell and when to get back in. Below is some updated information about the impact of making reactionary investment decisions.

Missing the Best Days

This table shows the fifteen best days for the S&P 500. Surprisingly, all of them occurred within bear markets, not bull markets as you might expect. That is, the big upturns in the stock market can happen during times when it is hardest to remain invested or tempting to get out of the market and wait for better days. Looking at these dates, you will find the who is who of dark times for the stock market: the 2008 financial crisis, the dot-com crash, the Black Monday crash of 1987, and the pandemic-driven market decline in 2020.By trying to miss the worst days, investors are very likely to miss the best days.  Missing just the ten best days (out of more than 17,500 trading days since 1950) has a huge long-term effect on a portfolio. For example, an investor who invested $10,000 in the S&P 500 in 1950 would have gained 7.9% annualized and finished with a portfolio value of more than $2.38 million (as of 5/10/2022) if they had remained fully invested (not including dividends). The final portfolio value for an investor that missed the ten best days is well below half that amount at roughly $1.07 million.

Remain Invested, Stay Disciplined, and Seek Actionable Opportunities

So again, we want to focus on what we can control and not let ourselves be distracted by things we cannot. What should you do?  Below are several of the more common actions we are recommending:

Rebalancing. Rebalancing means selling some of your better performing investments and buying a bit of your laggards (“sell high” and “buy low”).  Even in a difficult year when there are few “sell high” candidates, some investments will have done relatively better than others, even if they are both down temporarily. This can provide an opportunity to focus investments on what might have the better upside opportunity as things turn around.

Use market declines as an opportunity to harvest tax losses. A downturn in prices is not what we hope for when investing. But one way to make lemonade out of those lemons is to sell securities that are down from their purchase price. By “harvesting” those realized losses they can be used to offset taxable realized gains. This tax-saving strategy can be helpful today and possibly for many years into the future, since realized capital losses can be carried forward on your tax return. As we harvest losses, the proceeds from those sales are used to purchase investments in a similar category, so your portfolio allocation and opportunity to catch an upswing stay intact.

Confirm an appropriate “emergency fund.” One of the best strategies to help you sleep at night and allow yourself to stay invested during market volatility is to establish an “emergency fund” of cash left out of the market. We collaborate with clients to make sure they have an appropriate amount of cash set aside to fund either spending needs or just as an emergency fund. This is something we can discuss with you if it is an area of concern.

Revisit financial planning and/or cash flow projections. By reviewing how your resources will support cash flow needs into the future, we can help ensure that your spending should be sustainable. And if making changes to expenses in the near term would be advantageous, that could be a positive step to take during a challenging time. Reviewing scenarios for how the future may play out can be extremely helpful in creating the appropriate context for making decisions today.

Consider a Roth IRA conversion. Roth conversions offer the opportunity to transition investments from a traditional tax-deferred IRA account to a Roth IRA, where they will benefit from tax-free growth going forward. The conversion will be taxable, but a market downturn could be a suitable time to make this transition with assets that have fallen in price, as their subsequent growth when the market recovers will be in the tax-free Roth IRA.

Take breaks from the 24/7 news cycle. We encourage you to take time away from the news and daily updates. The constant news feed is focused on getting attention and benefits advertisers, not investors. It can be overwhelming to the viewer, and that can lead to unnecessary stress and anxiety. It is important to stay both physically and mentally healthy so you can make the best decisions for your overall benefit.

If you want to make drastic moves in your portfolio related to market events that you have no control over, try making a list of all the things you do control.  How much you are saving, evaluating the way you invest, spending less, where you aim your focus and energy.  Just imagine what kind of positive impact this may have on your life.  We can assure you it will have a beneficial one to your portfolio.

Perritt Capital Management, Inc. is the Registered Investment Advisor for Windgate Wealth Management accounts and does not provide tax advice. Consult your professional tax advisor for questions concerning your personal tax or financial situation and your insurance agent for insurance advice.

Data here is obtained from what are considered reliable sources; however, its accuracy, completeness, or reliability cannot be guaranteed.

First published August 2022.

Past Performance does not guarantee future results.

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