Well, it’s been a bumpy
ride. Actually, not even as bumpy as we’d like. More like a
free-fall on some days. The S&P 500 has dropped 25+ percent within
the last 4 weeks, and it’s not clear when we will hit the bottom of the trough.
Of course, the greatest concern on everyone’s mind is how to stay safe
and healthy during the coronavirus pandemic. However, many investors
can’t help wondering in a spare moment— what, if anything, should we do in
light of the recent market decline?
Several articles
in the financial press have advocated that investors “do nothing.” And,
to be sure, doing nothing is far better than doing something… if it’s the
wrong something. The current level of market volatility and the uncertain
economic outlook increase the possibility of adverse consequences if investors
make changes without the help of a trusted advisor. However, for those
with the knowledge and expertise to take advantage of it, the recent market dip
does present opportunities, depending on an individual’s situation, risk
tolerance, and assets.
Buying Stocks “On Sale.”
The first and most obvious opportunity is that, for
those with assets to invest for the long-term, this could be a great time to
“buy low” in the hopes of “selling high” down the road. If you have
significant bond investments, this could be a good time to rebalance and move a
portion from bonds into stocks. Similarly, if you have idle cash in banks
to invest in a taxable account, if you make annual contributions to a Roth or
traditional IRA, if you have a high cash balance in an HSA, this could be a
good time to move funds into the stock market.
When would this be a BAD idea?
If
you are trying to time the market. Last Thursday
seemed to be a fantastic day to invest. So, did last Monday… along with
several other days earlier in March. Investors
are notoriously bad at trying to time the market— and professionals are not
much better. That is why we at PFS do not attempt to do so.
Instead, we rely on a target allocation for client portfolios, based on their
personal risk tolerance and financial situation. This allocation tells us
how much to move into the stock market, assuming it’s appropriate for your
circumstances. For example, a client may have a target allocation of 60%
in stocks and 40% in cash and bonds. If their portfolio was in balance as
of mid-February, after the market decline of the past 4 weeks, the portfolio would
now have approximately 55% in stocks and 45% in cash and bonds. So, we
should move enough cash or bonds into equity funds to return to a 60-40
allocation. This is a disciplined and strategic way of taking advantage
of market volatility on the margins of a portfolio, without trying to guess
exactly when the market will hit its highs and lows. However, since our
crystal balls refuse to tell us exactly when the market will recover, we may be
more or less aggressive in rebalancing to a client’s target allocation,
depending on the client’s personal circumstances (see below).
If
you need the money. If your job may be
at risk in the current economic environment, if you need cash for upcoming
expenses such as a new car or tuition payments, if you’re on the brink of
retirement or are in retirement, if you may need to tap your HSA for
out-of-pocket medical expenses, this may not be a good time to move funds into
the stock market. Again, no one knows when the market will bounce back.
Make sure that any money going into equities can stay there for the
long-term.
If
you won’t be able to stomach continued volatility. Even
if you don’t need assets in the near-term, will you be able to watch your
equity investments drop another 10% or 20% in value without panicking and
selling them? If you move funds into the stock market only to face
increased anxiety and sell out of the market after another significant decline,
you would be better off doing nothing.
If
you don’t know what investments to buy. If you’re considering investing in the market
but don’t have a clear idea of what you would purchase and why, seek the help
of a trusted adviser before taking action.
At PFS, we avoid buying individual stocks and use only well-diversified,
low-cost, passively-managed investments.
We also try to capitalize on the relative performance of different asset
classes—e.g., if you think U.S. large company stocks are on sale, check out
U.S. small value stocks!
Harvesting Tax
Losses. If you have purchased stock funds in a taxable
account within the past couple years, you may be able to realize capital losses
in your investments, which would help reduce your taxes this year and possibly
for years to come.
When would this be a BAD idea?
If
you are unsure how to buy back similar securities in the same or another
account. Harvesting losses requires selling investments
when they’re down, and due to wash sale rules,
the IRS will not allow you to turn around and buy the exact same investments
immediately thereafter. On the surface, this seems to be doing the exact
opposite of the “buy low, sell high” mantra for investment success. You
can buy back similar investments, however, in the same or a different account
within your portfolio. This will allow you to harvest the tax losses
without locking in a loss in your investment returns. Note that this strategy will likely result in
larger taxable gains in the future.
If
you are unable to buy similar securities on the same day. With
one-day market swings of 5% to 10% occurring with some regularity over the past
few weeks, you could lose significant value by selling investments one day and
buying similar ones the next day. Ideally, any purchases of similar
securities would take place on the same day as the sales to harvest tax losses.
Roth Conversions. If your current tax bracket is relatively low and
you were planning to convert funds from an IRA to a Roth IRA this year, now
would be a good time to do it. You can
convert the same number of shares for a much lower price than a month ago, and
hopefully, by the time you use the Roth assets, the coronavirus will be a distant
memory. (Of course, prices may drop
further over the coming weeks or months, so it is impossible to say whether
this would be the “perfect” time to do a Roth conversion this year.)
When would this be a BAD idea?
If you are not in a low tax
bracket. Roth
conversions add to your taxable income, so they should only be undertaken
thoughtfully during periods of time that you have relatively low income. See our
blog on building Roth portfolios for more details.
The bottom line is that while the recent market decline presents some
investment opportunities, the consequences of making a wrong move could be
severe, especially with such high market volatility and the possibility of the
pandemic impacting jobs and income over the coming months. If you do not have expertise and/or
professional help for financial planning and investment advice, doing nothing
may be your best bet. For PFS clients or
those seeking help, please feel free to reach out any time as we navigate these
murky waters together.
