There are countless reasons to feel disappointed when your 401(k) statement is showing how much money you’ve lost over the last 30 days. A typical portfolio that’s invested in a mix of stocks, bonds, real estate and cash is likely to be down 17% or more from last year right about now. When you see losses like that in black and white, it might seem insane not to contemplate taking at least some money out of the market. But hold on.
As stocks have slid into a bear market, many people are asking themselves right now: Do I have too much in the market? And where would I re-invest that money if I did sell some stocks? However, a better time to ask whether you have too much money invested in stocks is when the market’s at record highs.
The voice of reason plus a good review of stock market history will remind you that the worst thing to do is pull your hard-earned savings out of the market all at once. Your inner financial adviser may also remind you that, while your investments have lost value on paper, you haven’t actually lost any money until you decide to turn that paper loss into a real loss by selling at the exact moment when stock prices have dropped.
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The Good Side to a Bad Market
Instead of considering all the ways a down market potentially hurts you, think about how the cycles that push stock prices lower can be good opportunities for patient long-term investors. Down markets present a chance to reposition your portfolio, and to do that, it helps to step back and see the big picture. Remember, you’re investing over a lifetime, not a few years.
The stock market will never go straight up, because that’s not how it works. Typically, bear markets last about 13 months, but they can last years. If you have time to allow the economy and business cycles to correct, you’ll likely be rewarded as the economy recovers. Since World War II, periods of economic expansion have lasted longer than contractions. The average expansion has run about 65 months, while recessions have lasted about 11 months, according to the National Bureau of Economic Research (opens in new tab).
Using a rearview mirror, we can see the best time to invest in stocks is when future company earnings are strong, multiples are low and stock prices are low. So, a question you may want to ask is, what can you do to reposition yourself in the market?
With that in mind, here are four strategies that work in a down market:
1. ‘Dollar-cost average’ your way into the market
If you’re currently building a nest egg and contributing a constant dollar amount month in, month out, then you’re already taking advantage of one of the most successful investing strategies there is, known as dollar-cost averaging. That means you’re automatically taking the emotion out of investing because you’re purchasing more and more shares each time they drop. This way you’ll end up paying an average price for those shares instead of trying to guess when to buy low and sell high.
Dollar-cost averaging is probably the most simple strategy for investing over a lifetime because it’s the one approach that actually protects you from emotional reactions that can harm you.
2. Hunt for value
You may want to consider buying high-quality stocks now while they are “on sale” while prices are low. A lot of stocks may have seemed overpriced for a long time while the bull market was raging. Now, while they’ve been beaten down, is your chance to find these quality companies more fairly priced, which means you can position yourself for better returns — again, based on the company’s future earnings prospects. Keep your focus on the overall economy versus day-to-day movements as it goes through this cycle and starts recovering, just as you keep your eye on the horizon when you’re on a boat in rough seas to prevent seasickness.
3. Seek stocks that pay dividends
The time to look for stocks that pay dividends is when prices are down. Dividend-paying stocks can be a hedge against inflation, tend to be less volatile in choppy market conditions and continue to pay investors a better overall return even when the market is in turmoil.
4. Consider tax-focused strategies
While dollar-cost averaging and dividend-paying stocks may help in your early and mid-career, if you are closing in on retirement, you may consider using tax loss harvesting to help reposition your portfolio. This strategy involves selling underperforming stocks at a loss and then using the proceeds to buy similar, but not identical, assets. Not only does tax loss harvesting enable you to get rid of the duds in your portfolio, but you can also use the loss to offset other capital gains in your portfolio and reduce your overall tax bill. The IRS allows you to deduct up to $3,000 in capital losses from your income per year.
Uncertain economic and market conditions can be unnerving. That fear can cause you to make big mistakes that seem like protective measures at the time, but those are the mistakes that can turn into massive losses. According to a MagnifyMoney (opens in new tab) study, of those investors who sold stocks last year when the market was down, 40% said they regretted that decision and wished they’d just stayed the course.
Time in the market and proper diversification are the best ways to protect your investments. Now’s the time to turn stress about the market into a stock market strategy.