5 Strategies in a Down Market
Hello, I’m James Studinger, financial planner, and author of Wealth Is a Choice. I believe wealth is a choice. And that people get wealthy by buying things that make them more money. I also believe people get poor by buying things that cost money to maintain or depreciate in value.
The topic of discussion today is - 5 strategies in a down market.
Most common regret (in down markets that have since recovered)
Over the past quarter century, when I’ve asked what regrets people had after a bad market recovered, their answers were unbelievably consistent. Pre-retirees regretted that they didn’t buy more shares of the market at low prices. Retirees with regrets, say they wished they hadn’t sold their shares at low prices.
What everyone would like to do, including me, is sell all our shares at the peak, then buy them all back at the bottom. I’d also like to win the lottery. Neither timing the peak and bottom of the market or winning the lottery are very realistic. However, that doesn’t stop people from trying.
The problem with a timing strategy is that it’s extremely possible to get it wrong. And if you do, then you could permanently secure losses. It can seem foolish to watch the market fall and do nothing, but historically speaking, it is the more reliable strategy.
5 strategies in a down market. Listed from less risky to riskier.
1. Stay the course – provided you have burn rate coverage.
The burn rate is a term I use to calculate how much money someone will spend over a period of years. For a simple math example, let’s say a couple takes out $50,000 per year from their investments. Over the coming five years, they will withdraw $250,000 of assets. If they hold a quarter million dollars outside the market, then it’s highly unlikely they will be forced to sell equities at a loss to pay their bills. That affords them the strategy of riding out a bad market. They won’t sell shares at losses, and eventually their shares will recover or even reach new highs.
The strategy is to make sure you have enough money not in the market to secure your spending needs. It goes without saying you are always doing a quality check on your investments, no matter if it’s a good market or bad market, to ensue you are holding the appropriate investments. Don’t ignore your investments in a downturn hoping they will come back to good value. They might not be positioned for a recovery; in which case it may make sense to change things around. Know what you own.
2. Convert to Roth, and get more shares for the same money
Let’s say you have an IRA with $300k in it, and you were considering converting $100k into a Roth. The market fell, and now your IRA is worth $200k. For illustration purposes, let’s assume that the account is made up of 1,000 shares of an investment. The investment was originally worth $300/share ($300*1,000 shares = $300,000) and is now worth $200/share. You still own the 1,000 shares. When they were worth $300/share, you would only have converted 333 shares to reach $100k conversion. Now you can convert 500 shares into the Roth for the same $100k.
Prior to the market reduction, you would have ended up with $200k in a regular IRA and $100k in a Roth. Now, assuming the market recovers, you will have $150k in the regular IRA and $150k in the Roth IRA. That’s a huge 50% increase to the Roth portion and it didn’t cost you a dime more in taxes than before. We use this strategy frequently. Please note, Roth conversions don't make sense for everyone, and you always need to be aware of the taxes that will need to be paid for converting.
3. Capture losses for tax purposes – the trick is to also participate in gains if they come soon.
This applies to non-qualified funds (money not in a tax deferred retirement plan like an IRA or 401k). It’s usually mutual funds or stocks held in a brokerage account. Let’s say you bought $100,000 of investments, and it’s now worth $70,000. If you sell the investments, you will be able to claim those losses to offset future gains. If you buy back the same investments within 30 days you won’t be able to claim the loss.
The trick is in finding investments that are just as likely to recover as the assets you sold. Then, if the market does recover before the 30 days you still participated in the gains. This is a strategy we sometimes use, depending on the specifics of each client’s account, and whether I expect to hold a particular investment for a very long time. I might keep an investment that I believe I will hold for many years so I don't "reset" the basis at a lower number and have to pay more in taxes in the future.
4. Move to cash – it’s tough to know when to get back in and keep with your conviction
With hindsight being 20/20, this is what everyone dreams of doing. Trust me, I still reflect on the “what if” scenario of selling out of the market in the beginning of 2008 and buying back into the market in late March 2009. The problem with this daydream is buying back in would have been incredibly difficult to time. The world was falling apart financially and yet the recovery started quickly and with vigor. Missing that early recovery stage would have been detrimental.
When people try to time the market, they tend to buy and sell more often than they anticipated and can lose quite a bit of money in the process. Markets don’t typically have a straight fall, bottom, and then immediately recover. They go up and down in massive swings giving us plenty of head fakes. Someone thinks they are in a recovery because the market goes up massively one day, and so they buy back in. And then the market takes a huge dive later that week. So, they freak out and sell. Only to see the market go back up the following week.
This bad timing investor dynamic was made famous with a study at Fidelity, measuring the Fidelity Magellan Fund managed by Peter Lynch from 1977 to 1990. Under his management, it averaged an outstanding 29% annual return. However, according to Fidelity, the average Magellan Fund investor lost money during Lynch’s reign.
All people had to do was stay invested, but they got in and out of his fund and paid the price.
5. Bet against the market (short) – This is wonderful when you get it right. It can double the loss when you are wrong.
The strategy that is even more risky than getting out and back into the market is to get out and bet against the market, and then get back in. For example, someone might sell their investments when the market is falling, and buy an investment that shorts the market, which typically goes up in value when a market falls. This can be very tempting, and in hindsight seems so obvious. It also makes people famous when they get it right, like The Big Short (Michael Burry betting against the sub prime loan debacle). Michael ran a hedge fund leading up to the 2008 financial crisis. He believed the credit markets were very messed up and thought at some point there would be a huge correction. He was eventually correct and made tons of money when most people around the world were losing money.
Unfortunately, very few people get it right (that’s why they are so famous when it happens). And if you get it wrong, then you can lose lots of money on both sides of the trade.
I tend to stick with strategies that historically have proven to not lose money
I’m working with strategies 1, 2 and 3. (Staying the course, converting to Roth, capturing losses) I’ve avoided using methods 4 and 5 (going to cash, shorting the market) in this environment. I don’t know when we will hit the bottom, or how long it will take to get back to previous market highs. But I do believe both will happen eventually. Please call if you have any questions, thoughts, or concerns. It is painful to see the value of something be less than it was before. We are doing our best to ensure all your value returns and then some! I believe that sticking with principles of building wealth is the best way for this to happen.
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Thanks,
James
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. JP Studinger Group, LLC is not affiliated with Kestra IS or Kestra AS. Investor Disclosures: https://www.kestrafinancial.com/disclosures
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.