During a volatile market environment like we find ourselves in today, or the steep market pullback at the onset of the pandemic in 2020, many investors feel a powerful urge to take action. When markets are down sharply, there is a common temptation to sell stocks in an effort to reduce risk. While selling stock creates a sense of control that can make people feel better at the moment, it is often exactly the wrong thing to do during a market downturn.
For long-term investors, trying to time market tops and bottoms is a fool’s errand. The evidence overwhelmingly demonstrates that most investors diminish their long-term returns when trying to do so. These investors are more likely to chase the market up and lose twice by buying high and selling low. Market timing, while tempting, involves getting two nearly impossible decisions right: when to sell and when to re-enter the market.
Even when following the advice to remain invested during a market downturn, an investor does not have to sit passively on the sidelines and do nothing. In this article, we suggest six actions investors can take to keep their financial goals on track during periods of market volatility.
Remain Invested, Stay Disciplined, and Seek Actionable Opportunities
In suggesting actions to take when markets fall, many professional advisors focus on what investors can control and not let them be distracted by things they can’t. With this theme in mind, below are six actions advisors may recommend during market downturns:
- Keep a long-term perspective. One of the important benefits of working with an experienced advisor is that they can help you manage your financial situation in a holistic way, which will enable you to stay disciplined and true to your long-term investment strategies. This is true both for your existing investments as well as any new investments you plan to make over time. Rebounds can happen quickly and the cost of missing them is significant over time. Recognizing this, most advisors will try to help their clients remain invested and do so at a reasonable allocation level.
A long-term focus can also lead to an opportunity to add to stocks prudently and incrementally when their prices become more attractive, and their future expected returns are better. With this strategy, one can potentially take advantage of a volatile market environment by adding to investments at prices likely to generate far better long-term returns than what was possible before the downturn. By maintaining a long-term perspective, investors can participate in market recoveries and keep their portfolios on track for reaching their long-term financial goals.
- Confirm an appropriate “emergency fund”. One of the best strategies to help you sleep at night, even during market volatility, is to ensure the funds you need for spending in the near future are not at the mercy of short-term market movements. Advisors often work with clients to make sure they have an appropriate amount of cash or low-volatility investments set aside to either fund spending needs or use as an emergency fund—keeping this money steady when the near future is unknown.
- Revisit financial planning and/or cash flow projections.By reviewing how your resources will support current and future cash flow needs, an advisor can make certain that your spending levels are sustainable or make suggestions to curtail expenses for the short term. Reviewing scenarios for how the future may play out can be very helpful in creating the appropriate context for making decisions today.
- Use market declines as an opportunity to harvest tax losses. A downturn in prices isn’t what we hope for when investing. But one way to make ‘lemonade out of 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 one harvests losses, the proceeds from those sales are used to purchase investments in a similar category, so the portfolio allocation and opportunity to catch an upswing remain intact.
- 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 good 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. Advisors often encourage investors to take time away from the financial media. The omnipresent news feed is focused on attracting attention and benefits advertisers, not investors. It can be overwhelming to the viewer, which 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.
Conclusion
Market downturns are never enjoyable. For many investors, seeing values plummet leads to an emotional decision to “do something,” which too often translates into a desire to sell assets. A focus on positive actions can help one avoid the dangers of attempting to time the market. In this article, we outlined six actions to take during a market downturn that can positively impact one’s long-term wealth planning.