How to Make Your Money Work for You During a Downturn
It’s never fun to watch the value of your portfolio drop during a market downturn. In fact, it’s often during downturns that investors panic and sell at the bottom, locking in their losses and demonstrating why pessimism does not serve investors well. Instead of selling at a loss, look for ways to position your portfolio to take advantage of the market’s eventual recovery. There are many opportunities during bear markets, as detailed below.
First, it’s important to understand that significant market downturns occur typically and are a normal part of the markets. On average, a 10 percent downturn occurs every 11 months. Typically, a bear market is defined as a period during which securities prices fall 20 percent or more from recent highs amid widespread pessimism and negative investor sentiment.
While a drop of 20 percent may sound scary, bear markets also offer opportunities. Following are three tips to help you capitalize on volatile market conditions.
When the market is down, avoid fear-driven selling
Fear-driven selling is the single biggest mistake investors make during market volatility. The COVID-19 bear market lasted a mere 33 days from February 19, 2020, to its trough on March 23, 2020, yet a lot of fear-driven selling occurred during this short timeframe.
By selling out and moving to cash, you can miss out on the three main opportunities of investing during a bear market.
- Rebalancing – selling high/buying low – Rebalancing is the process of realigning the blend of assets back to a target allocation when they drift out of balance due to market movements.
For example, let’s say you own stocks and bonds. In a bear market, when stock prices drop, your portfolio will own a smaller percentage of stocks compared to bonds. To rebalance your account, you sell a portion of your bonds to purchase stock, which boosts your stock percentage back to your desired target. The opposite would occur during a market upturn; your portfolio would end up with a larger percentage of stock, so rebalancing would lead you to sell stocks and buy bonds within the portfolio.
Periodically rebalancing your portfolio in this way is designed to allow you to sell high and buy low.
- Dividend reinvestment – Stocks and bonds often pay dividends and interest, which are an important part of an investment’s total return. Reinvesting your dividends allows you to:
- Grow your portfolio through the purchase of additional shares. When shares cost less during a market downturn, you’re able to buy more shares with the same amount of money.
- Take advantage of compounding interest within the portfolio.
These are two major benefits you sacrifice when you take your money out of the market.
- Tax-loss harvesting – Tax-loss harvesting is the process of realizing investment losses in order to lower your tax liability and limit the taxation on future gains. Many investors ride the ups and downs of the stock market by following a buy-and-hold strategy. While this strategy typically makes sense within an IRA, it’s often wise to consider tax-loss harvesting within your after-tax accounts.
Investors are forward-looking. Market lows typically occur about four months before the beginning of an economic recovery. Warren Buffet offers wise words in his famous quote, “We simply attempt to be fearful when others are greedy and to be greedy when others are fearful.” It’s all about time in the market, as great opportunities can be missed when you take your money out. The following chart illustrates how missing just a few days in the market can greatly impact a portfolio’s performance.