March 24, 2016
Nobody likes to see the value of their investment accounts fall, but whether it’s a correction (a drop of at least 10% but less than 20%) or a full-on bear market (a decline of 20% or more) the reality is that markets go through rough periods. Always have, and always will. That makes it important to be extra smart in how you react when the markets are falling. Make a wrong move and you could derail your long-term security.
Here’s how to handle any bad stock market:
1. Relax. Falling stock prices are a good thing for long-term savings. If you are saving for retirement or another goal that is 10 or more years off in the future, you should be happy stock prices are down. When stock prices are lower, your money buys more shares. And then you own more shares for when stock prices rebound. For example, let’s say you are contributing $500 a month to a stock fund. If a share of that fund costs $25 you can buy 20 shares. But if the share price falls to $20, your $500 now buys you 25 shares. Let’s jump ahead 10 years. The share price is now $55. If you owned 20 shares you would have $1,100. If you owned 25 shares you would have $1,375. When time is on your side, a down market is a great chance to “buy low.”
2. Revisit your strategy. If you are suddenly jittery because stocks are down 5% or 10% or 20% or more, ask yourself why. If you’re a long-term investor the losses you are seeing today are likely coming after strong gains during bull markets. For example, from the bear-market low of 2009 through the spring of 2015, the S&P 500 had a total return of more than 200%. Since then, through mid-February of 2016 the index is down about 15%. That’s not pleasant to experience, but it’s important to keep it in the context of the longer-term returns. That said, if you just let the stock portion of your portfolio grow and grow and grow, that’s a mistake. If your goal is to have 60% invested in stocks but you haven’t paid attention for a few years, and that climbed to 70% or more, a rebalance is long overdue.
3. Make the most of losses. For any investments you own in taxable accounts, you can save some money by selling losers. When you sell an investment you have owned for at least one year for a loss you get to claim a long-term capital loss on your tax return. If you also have a realized capital gain, the loss is used to offset the gain. That of course reduces your tax bill. No offsetting capital gains? You can deduct up to $3,000 of a capital loss against your income (if your loss is more than $3,000 you can keep claiming the loss in subsequent tax years.) Any asset you own for less than one year is considered short-term. If you have a short-term loss it must first be applied to offset any short-term gain (which btw, are taxed at ordinary income tax rates). No short-term gain? Okay, then your short-term loss is applied to any realized long-term gain. If you don’t have that, then you get to deduct the loss against your income (again, up to the $3,000 annual limit.)
4. Don’t get too conservative. Selling your stocks and moving your money into cash or short-term bonds would no doubt feel soooo good right now. But please be careful. What makes you feel better when stocks are falling can become a big problem. The reality is that bank CDs and short-term high quality Treasuries aren’t yielding enough to keep up with inflation. And for any long-term goal (retirement money you will live off 10, 20, 30 or more years from now) you need to earn more than inflation, so you will be able to afford future (higher) priced goods and services. Sure, I know your thought is that you will wait for stocks to stop falling and then get back in.
That’s incredibly logical, yet ridiculously hard to pull off in reality. What happens is that you will likely still be sitting on the sidelines when stocks rally and so you miss out on the gain. Over the long-term stocks are your best shot at inflation-beating gains. Read that carefully. I said over the long-term. That’s why your long-term plan should always have some exposure to stocks. How much depends on your personal situation. One rule of thumb for your retirement money you might consider is to keep your age in safe investments. So if you are 60 you might have as much as 60% in CDs or short-term Treasuries, and the rest can stick with stocks. For the long-term.