Actions to Take Following a Market Drop
No one likes to see their portfolio balance drop following a market sell-off, but those who keep a cool head are often in a better position for growth once the market rebounds. The following tips can help you take advantage of opportunities following a market dip.
Tip #1 – Remind yourself of the purpose behind your investments.
Remember you are a long-term investor. Even if you’re currently living in retirement, part of your portfolio should be allocated for long-term growth. That long-term growth potential is likely generated, in part, by stocks. Because stocks represent an ownership interest in a business, they’re inherently risky. However, if you worked with a qualified wealth manager to allocate your investments, the risk you’re taking should be in line with your overall risk tolerance and long-term goals. During periods of volatility, remind yourself that your portfolio was built to withstand market fluctuations.
Tip #2 – Remain diversified.
Historically, one of the best ways to weather market volatility is by investing in a portfolio that contains a diversified mix of asset classes, investment types, industries and regions. The reason is simple – when one type of asset performs poorly, another investment type that’s performing better can help smooth out volatility within your portfolio. Diversification won’t prevent losses, but it can reduce the risk of being too heavily invested in the worst performing part of the market. You can diversify by combining stocks with bonds, large company stocks with small company stocks, U.S. stocks with international stocks, and stocks from different sectors, like technology, financial, energy, healthcare, etc.
Tip #3 – Take advantage of opportunities.
Market sell-offs can provide a great opportunity to pick up additional shares at lower-than-normal prices and lower your tax liabilities. To do so, your wealth manager can help implement the following strategies:
- Opportunistic rebalancing – This is the process of realigning a portfolio’s blend of assets back to a target allocation when it drifts out of balance due to market movements.
For example, let’s say you own stocks and bonds. When stock prices drop, your portfolio will own a smaller percentage of stocks compared to bonds. Using an opportunistic rebalancing strategy, your wealth manager would sell a portion of your bond allocation to purchase stocks, 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 us to sell stocks and buy bonds within the portfolio.
Periodically rebalancing your portfolio in this way is a strategy designed to help you sell high and buy low.
- Dollar-cost averaging – This is the process of investing money at regular intervals over a long period of time. A great example of dollar-cost averaging is making regular payroll deferrals to a company-sponsored retirement plan. The benefit of this approach is that you’re able to buy more shares when prices drop, which can help lower your average per-share price.
- Tax-loss harvesting – Within your portfolio, you’re only taxed on net capital gains, which equals gains minus losses. Tax-loss harvesting is the process of strategically selling an investment that has declined in value and replacing it with a highly correlated alternative. By doing so, you realize a loss that can be used to offset your tax liabilities while maintaining your portfolio’s target allocation and risk profile.
However, it’s important to exercise caution when using this strategy; if done incorrectly, it can trigger the wash-sale rule. The wash-sale rule applies when an investor sells a security at a loss and, within 30 days before or after the sale, buys a substantially identical security. If the transaction is deemed a wash sale by the IRS, you won’t be eligible to write off the investment loss, which could result in a higher tax bill than you expected.
Fortunately, your Creative Planning team is experienced in actively tax harvesting client portfolios and proactively implements this strategy on your behalf without triggering the wash-sale rule.
At Creative Planning, we help clients make smart investment decisions throughout all phases of the market cycle. Please schedule a call if you’d like help navigating market volatility, or with any other financial matter. We look forward to working with you.