Well, it’s official. Last Friday, the S&P 500 briefly entered Bear Market territory as it slipped 20% from its previous highs and the Nasdaq down over 30%. It has been another “sell-everything” environment, reminiscent of March 2020, with even fixed income taking a 10% hit.
It has taken a variety of headwinds over the last six months to get us here. The end of 2021 was peak COVID 19 which largely contributed to supply chain issues and high inflation. Throw in a war in Europe to further exacerbate inflation and, subsequently, the likelihood of interest rate hikes, and it’s not surprising the market has gone into panic mode.
But, as always, we appreciate the calmness and trust that our clients have placed in us. This is nothing out of the ordinary and absolutely has been planned for. Times like this can also present some planning opportunities, so here are the four best things to do in a bear market:
1) DO NOTHING
- "This time it’s different... not really.” It feels different every time, but it rarely is. Markets are driven in the short term by emotion, and emotions are the last thing you want influencing your investment decisions. As you can see in the chart below, double digit drawdowns in the S&P 500 are almost a biannual occurrence. The truth is any long-term investor must get comfortable with the idea that they’ll face large drawdowns often, it’s just part of the game.
Source: First Trust
- My favorite part about market volatility is a special CNBC segment that airs called Markets in Turmoil. If you were to invest every time this show aired, you would look like a genius. This tv show has a tendency to indicate we are either at the bottom, or very close to a bottom. The good news is... it aired earlier this month!! Now this is all good fun, but this indicator has worked 100% of the time, every time. As you can see below, the 1-year forward return has always been positive after the airing of the show.
- What’s even better than doing nothing is buying the dip. If you have spare cash on the sidelines, or other investments that aren’t at as much of a loss such as fixed income or annuity free withdrawals, now is a great time to deploy it. Everyone knows the classic “blood in the streets” quote from Warren Buffet, but my favorite Warren Buffet quote is “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” Everyone likes a good deal, which is precisely why I will never venture out into those crazy Black Friday crowds. The irony is, when the market gives investors Black Friday deals, their inclination is to do the opposite to stop the pain of seeing red numbers.
- The chart below shows some of the worst 1st quarters we’ve seen over the last century. As you can see, you’d rarely regret buying at any point during a 10%+ Q1 correction. Source: First Trust
3) WHEN LIFE GIVES YOU LEMONS, MAKE LEMONADE.
- Market dips can leave a sour taste in your mouth, but beyond buying-the-dip, there are a couple other financial moves you can make. The first is doing a Roth Conversion. This involves shifting money out of a pre-tax IRA and moving it into a tax-free Roth IRA. The advantage here is that when the market recovers, the growth will be tax-free in your Roth IRA.
- The other planning opportunity is what we call tax-loss harvesting. This means selling a position at a loss, and rebuying a similar position. This harvests your loss, allowing you to use it to offset future gains, or better yet, save you some money on your tax return (limited to a $3k deduction per year and can be carried over).
Please remember, when triggering taxable events, to consult with your tax advisor prior to making a decision.
4) REASSESS YOUR RISK TOLERANCE
Risk tolerance can be broken down into 2 components: ability to take risk and willingness to take risk. The problem with risk tolerance is that it is constantly changing based on market conditions.
When I first got into the business in 2010, investors were not willing to take on much risk, if any. The pain of ‘08 was still fresh in their memories. As that memory began to fade, over the course of the next decade, investors were much more willing to take on risk, in fact, many became risk-seeking to capture as much market growth as possible. People tend to have a higher willingness when the market is in smooth-sailing mode. Once the party is over and the market moves lower, they are often left facing losses they never expected when they made the decision to take on more risk.
That is why a lot of our conversations with clients revolve around their ability to take risk. How much can you afford to lose and still maintain your lifestyle in retirement? The answer is different for every client and understanding your ability to take on risk gives you a much more honest picture of your true risk tolerance. Don’t forget about your willingness to take risk, though. Just because you can afford to take more risk, doesn’t mean you should. Mike Tyson once famously said “everybody’s got a plan, until they get punched in the mouth,” and understanding both components of your risk tolerance will help you stay in the fight, even after the market just knocked out one of your front teeth.
In summary, this is normal. There’s no need to panic, but if the volatility is keeping you up at night, please let us know, and we can always reassess your plan.