What Not to Do During a Market Downturn
The U.S. stock market has officially entered a bear market, the term used to describe a decline of at least 20% from the market’s most recent high. Bear markets are a normal and healthy part of the market cycle. In fact, most investors will experience several of them in a lifetime. While seeing your account balance drop can be disconcerting, bear markets also offer opportunities to grow your portfolio. The key is to avoid making common missteps that could cause permanent damage to your future investment outlook.
As we enter this latest bear market, avoid these five common mistakes.
Mistake #1 – Running from volatility
Yes, volatility is scary, but it can also be beneficial to your long-term success. Exiting the market during periods of volatility can be detrimental in three key ways:
- Selling out at a loss (which, by the way, only becomes a realized loss when you finalize the sale).
- Missing out on the chance to participate in future market rebounds.
- Missing out on the opportunity to buy additional shares at a reduced price. Bear markets are a great opportunity to sell high-quality bonds in order to purchase stocks at lower prices than normal (a strategy referred to as rebalancing).
The key to success during a bear market is to have an investment strategy in place to help manage volatility and put you in a better financial position once the bear market ends. Your wealth manager will help you implement a bear market investment strategy that is in line with your overall risk tolerance, investment time horizon and goals for the future.
Mistake #2 – Not having cash on hand
While it’s not wise to run from volatility, it’s also not wise to be caught unprepared. When an unexpected bear market rears its ugly head, you don’t want to be forced to sell out of your investments in order to fund your daily living expenses. That’s why it’s important to keep some cash in an emergency fund, such as a savings account.
During a bear market, an emergency fund can prevent you from having to sell investments at a loss to pay your bills or cover an unexpected expense, such as replacing your furnace or paying for a car repair. Selling stocks at the bottom of a market cycle will make it more difficult to recover, as you’ll have less money invested in the eventual stock market recovery. It’s wise to have at least three to six months’ worth of living expenses in your emergency fund to avoid tapping into your investments at an inopportune time.
Mistake #3 – Triggering the wash-sale rule
Tax-loss harvesting can be a wise tax strategy to implement during market downturns. However, when done improperly it can trigger the wash-sale rule, which would disallow your capital gains tax deduction.
The wash-sale rule occurs 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 will not be eligible to write off the investment loss, which could result in a higher tax bill than you expected.
If you’re a client of Creative Planning, your team is experienced in actively tax harvesting client portfolios and proactively implements this strategy on your behalf without triggering the wash-sale rule.
Mistake #4 – Relying on the opinions of panicked pundits
Most of us know the main goal of media news outlets is to drive ratings. Yet, during periods of uncertainty, many of us rely on news websites and television programs to guide our reactions. Unfortunately, news headlines and talking points are often exaggerated in order to motivate more people to click or tune in.
If you find that disturbing news headlines cause you to lose sleep during periods of market volatility, it may be wise to limit your exposure. Take a break from your regular programming to watch a movie, go for a walk or read a book. If you’re really worried, reach out to your wealth manager for reassurance.
Mistake #5 – Constantly checking your accounts
Remaining up to date on your financial status is an important part of being a responsible investor. However, constantly checking in on your accounts through periods of market volatility can lead to unnecessary stress and make it more likely that you’ll respond emotionally to market drops.
As long as you have a long-term investment strategy in place, you don’t need to check your accounts at every bump in the road.
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 the current bear market, or with any other financial matter. We look forward to working with you.