[The following originally published as one of my regular columns at MDMag.com is all about what you should do in a bear market. When I wrote it (and as I write this) I wasn’t really sure where the markets would be at when this actually runs here on the blog. Perhaps we will be in a bear by then, or perhaps it will have recovered completely. At any rate, like most of the stuff I write here, I write content to be “evergreen” so it is still useful when people read it 5 years or even 20 years from now. If it no longer applies as you read it, come back in 3 or 4 years when we have our next bear market.]
As the recent stock market correction threatens to turn into a bear market, this is a good opportunity to review the things you should, and shouldn’t do in a bear market if you hope to be successful at reaching your investment goals. The information in this post assumes you had a reasonable, low-cost, broadly diversified, written investing plan in place at the start of the bear market. If that isn’t the case, develop and write down a reasonable investing plan first, then come back and read this.
1. Do Nothing
Many investors repeatedly shoot themselves in the foot due to a lack of discipline and good investing behavior. Investors typically buy high in a bull market euphoria and then sell low in the bear market doldrums. You can beat the average investor by simply doing nothing. Don’t look at your portfolio values. Don’t watch financial news. Don’t read the newspaper. Don’t open your investing statements. Even if you decide not to do anything else in this list, at a minimum, be sure to do plenty of nothing during a bear market. By the time you’ve noticed the market heading down, it’s probably too late to sell high in hopes of buying low later. Besides, your cloudy crystal ball isn’t going to tell you when to buy any more than it told you when to sell. Forget trying to time the market and realize that it is time in the market that matters. The money in your retirement portfolio won’t be spent for decades, so invest like it.
2. Tax Loss Harvest
If you are investing in a non-qualified or taxable account, Uncle Sam has volunteered to share the pain of your losses. Although the natural thing to do when your investment goes down in value is to hold on to it in hopes of “getting back to even” the smart thing to do is to sell it and buy something very similar, but in the words of the IRS, not “substantially identical,” at the same time. This way, you get to use the loss on your taxes, but your investments perform essentially the same. This is called “tax loss harvesting.” Those tax losses can be used to offset future capital gains and you can even deduct up to $3,000 per year against your regular income. Although that decreases your basis, and thus may possibly increase future taxable gains, you benefit from deferring the gains for years, and possibly even until a time when you are in a lower capital gains tax bracket. You can get out of recapturing those gains completely by donating appreciated shares to charity or by dying and leaving the appreciated shares to your heirs, who will get to enjoy the step-up in basis at death. That allows them to sell the investment without paying any taxes on all of those gains that occurred during your life.
3. Evaluate Your Risk Tolerance and Asset Allocation
A bear market, especially your first one, is a great time to find out whether your risk tolerance is as high as you thought it was. Since you based your asset allocation, or written investing plan, on an estimate of your risk tolerance, now is the time to find out if you guessed too high, too low, or about right. If your risk tolerance is higher than your asset allocation, now is a great time to make your asset allocation more aggressive. You may not be buying low at the market bottom, but you are certainly getting a better price than was available at the last market top. If you find out that, like many investors, you are lying awake at night worrying about the money you have lost, that is a sign that your asset allocation is too aggressive for you. However, now is NOT the time to change to a less aggressive asset allocation. That time is now one, two, or perhaps even three years away, when the bull has reappeared and most or all of your losses have been recovered. If you simply cannot stand it, try to just sell a little. You will be surprised how little it takes before you can sleep again. Sell down to the sleeping point, but do not panic and “go to cash,” selling all of your investments. I have worked with physicians who have made that mistake. They’re still working, unlike other physicians their age with better investing discipline.
4. Review the Cost of Your Investment Advice
When things are going well, and your investments seem to be trees growing to the sky, it seems very reasonable to share that success with your investment advisor. However, when many investors realize their advisor is making good money even when they are losing money in a bear market, they start rethinking the advisory relationship. Paying typical fees to even a good investment manager can have a dramatic effect on the size of your nest egg. After 30 years of earning 8% before fees and paying 1% to an advisor, you will end up with 17% less money than if you did not pay that 1% fee each year. While it hurts to temporarily lose 15% or 25% of your nest egg in a bear market, it should hurt even more to permanently lose 17% of it gradually over 30 years. Consider the guaranteed way to boost your nest egg by 17% by learning how to do what your investment advisor is doing for you by yourself.
Many investors don’t realize that a large percentage of their long-term investing gains are made during a bear market. A bear market is the time to be pouring money into the market, buying low, rather than taking it out. Thus, it is a great time to defer some of your major purchases. This is not the time to buy a new car, purchase that boat you’ve had your eye on, remodel the kitchen, or take that dream trip to Tahiti. This is the time to fund your Backdoor Roth IRAs, accelerate your 401(k) contributions, start that taxable investing account and take advantage of the fact that physician incomes tend to be quite stable even in economic recessions. Physicians, more than many people, can afford to continue to invest in a bear market, buying low and boosting long-term returns.6. Learn Market History
If you find yourself worrying about all the money you lost, this is probably a great time to improve on your financial education. I would suggest starting with a review of stock market history. You will quickly see the stock market drops by 5% or more about three times per year, by 10% or more (a correction) about once per year, and by 20% or more (a bear market) once every 3-4 years. Over your 60 year investing career (30 years working and 30 years in retirement) you will need to go through about 60 corrections and 20 bear markets. Might as well get used to it. This is normal market behavior. The chances that this time is different are very low. So far this century we have had a bear market in 2000-2002, in 2008-2009, and in 2011. It should be no surprise when one shows up in 2016. Your written investing plan should assume this will occur, and give you instructions about what you should do when it does occur. All you need to do is follow it.
What do you do in a bear market? Why do you do that? Comment below!