The stock market is down, now what?
Stocks in publicly traded companies around the world have had a very tough October. The S&P 500, a measure of large US stocks, is down over 8% in October alone which has wiped out the gains from earlier in the year, and leaves the benchmark down 0.02% year-to-date. This isn’t particularly surprising as we have had a very healthy stock market for a very long time and a correction of this sort is not uncommon. However, if you are an investor, especially those closer to needing the funds for things like retirement, it is unsettling to say the least. Here are some pointers on how to handle this downturn based on my twenty plus years of experience and market history.
Know your allocation
If you are working with an advisor or are using a technology platform you should have an idea of what your portfolio allocation should be based on your risk tolerance. This is expressed as a percentage allocation to stocks, bonds and cash, for example a 60% stocks and 40% bonds and cash allocation. Generally speaking the more money you have in stocks the more risk you are taking in your portfolio, and the more potential gain you have over a long-term market cycle. Determining the proper amount of risk to take in a portfolio is a complicated process and is based on your financial goals, psychological makeup and liquidity needs, among other factors. For my clients, I use a comprehensive psychological assessment and match that finding with a client’s financial goals. However you get there, you should know that you should have a certain percentage in stocks and the remainder in bonds and cash.
Now that you know what type of allocation you should have check your investment accounts, including your 401k, to determine if you still have the correct percentages. After a sell off like this it is not uncommon for a slight adjustment to be needed. It is counter-intuitive, you end up selling good performers and buying more of the bad performers, but academic research and practical application suggests this is the right move to make. Of course, you have to take into consideration the costs of rebalancing such as taxes and transaction costs. If you want to take a deep dive into this practice here is a white paper from industry leader Vanguard.
Tax loss harvesting
Sell offs present opportunities such as the ability to add to your position (see rebalancing) and to take advantage of tax loss harvesting. If you have positions in non-tax deferred accounts – ones that you receive a 1099 tax form annually- you should review your positions to see if there is the opportunity to harvest tax losses. This is the practice of selling a security at a loss and replacing it with a similar security so that you can use those losses to offset taxes in the future. Depending on your particular situation you could offset similar gains or offset ordinary income up to a certain point. For some of my clients I use a platform called Betterment that harvests losses automatically based on market moves. Here is a detailed explanation of how this is done.
This is the second to least most technical aspect of of these pointers, but if you have a five plus year time horizon for funds now is a good time to put those into the market. Of course you should stick to your allocation which was discussed above but think of the recent sell off as stocks going on sell. I don’t know (nor does anyone else), if they say they do they are lying, what the market will do in the short term. It could go lower, but history tells us that it goes up more than it goes down. For the vast majority of people, having an appropriate allocation to stocks is necessary to meet your long-term financial goals, and this sell off is a potentially good entry point.
The least technical aspect is simply do not panic and make a bad decision. It is easier said than done I know but focus on your long-term goals and how you are going to get there.
I work with families and businesses helping them plan and protect their financial future. If you have any questions about this article, or any other matter please feel free to contact me.