It has been nearly 10 years since U.S. stocks were in a bear market. Time to brush up on some proven techniques.
Many investors might have forgotten (or, for the younger ones, never knew) how to survive a bear market—after all, there hasn’t been one, by the most common deﬁnition, since the last one ended in March 2009.
But investors got a reminder about down markets and volatility at the end of 2018. The memory is fresh, even after January’s rally—the best January for stocks in 30 years— which won back some of the declines. The Dow is still 7% below its record high in October, before the slides. Watching their brokerage and 401(k) levels fall made investors itch to disregard the buy-and-hold strategy that works best for most individual investors over the long term. Giving in to that itch would be a mistake, experts say.
As investors try to cope with the prospect of a down market, the ﬁrst thing to remember, says Tim Steﬀen, director of ﬁnancial planning at brokerage house Robert W. Baird in Milwaukee, is that “while the movements we saw in December might have seemed extreme, on a historical basis they really weren’t all that extreme.”
Since 1950, there have been 36 stock-market corrections, or drops of at least 10% from recent highs. After each, the market has ascended to new highs, says Kurt Spieler, chief investment oﬃcer, wealth management, at First National Bank of Omaha. “How you lose money in the stock market is by selling at the wrong time,” he says. (Meanwhile, by rule of thumb, a 20% drop signals that a bull market has become a bear market. That is the drop that investors haven’t had to endure since 2009.)
Here are some other investing truths about down markets that have stood up over time, and that investors should keep in mind as they navigate forgotten territory:
1. Don’t try the ‘Hail Mary’ pass
It is usually a mistake to double down or pour money into one risky investment in the hopes of making up your losses quickly. The markets aren’t a casino (though they might seem like it sometimes). “Don’t feel the need to try to recover all that in one fell swoop by making it up in one investment,” Mr. Steﬀen says.
Nick Pennino, a ﬁnancial adviser at the brokerage Edward Jones in Hermosa Beach, Calif., advises clients to keep an emergency fund for expected living expenses for three to 12 months. Not everyone is able to squirrel away extra cash, of course. But if you’re able, you are less likely to panic when your investments fall and you attempt to sell at a loss, Mr. Pennino says.
2. Use dollar-cost averaging
Don’t keep all your money on the sidelines, experts warn. If a bear market scares you away from investing, you won’t lose money, but you’ll also have no chance of making signiﬁcant returns. “The best way to build up a portfolio is to stay invested for the long haul,” Mr. Steﬀen says.
A tactic that many market experts recommend is dollar-cost averaging. This involves spreading your purchases evenly over a long period—say, a year or two years—so that you buy the mutual fund or exchange-traded fund at an average price that smooths out highs and lows. “[Dollar-cost averaging] allows investors to do some of what they need—get the money invested—but gives them some of what they want, assurance that if it all goes down tomorrow, at least I didn’t put it all in,” Mr. Pennino says.
This technique draws on behavioral ﬁnance, forcing you to commit to buy a prescribed amount of shares on a set date, without room for emotion or thoughts of market-timing. Many brokerages allow you to set up automatic transfers, removing you from the driver’s seat entirely after you have initially decided what to buy.
But just as dollar-cost averaging saves you from paying the highest prices for the assets you buy, it also irons out the basis in your stocks—which means you won’t have as large a gain as someone who bought at the lowest point. If you have a lump sum to invest, rather than a small amount each month, you may be better oﬀ investing it all at once, mainly because keeping it on the sidelines in cash while you wait to meter it into the markets will drag down your returns, a 2012 Vanguard study found.
“If you’re uncertain about the way markets are going to go, to avoid the worst-case scenario, you also have to realize you may not make as much in a year,” says James Cox, managing partner of Harris Financial Group in Richmond, Va.
3. Mind your RMDs
Down markets can be the hardest on retirees. Investors older than age 70½ must withdraw at least some of their money from retirement accounts each year—a painful proposition when markets have fallen sharply. These annual payouts, known as required minimum distributions, are required by law because Congress, when providing tax beneﬁts for individual retirement accounts, 401(k)s and other plans, didn’t want people to shelter all their savings forever.
There are exceptions to the requirement. But in general, remember that you don’t have to take these distributions at any particular point during the year. So, if the market stumbles, you can defer your distribution in hopes that markets recover in the meantime, Mr. Cox says. Of course, the market could drop further, so each IRA owner has to call the market, as it were, when making decisions about when to withdraw. That can be tricky.
It is also permissible to transfer shares or investments from your retirement account into a regular taxable account, taking your distribution “in kind” rather than in cash, as some four out of 10 Harris clients do. When you eventually sell those assets in your brokerage account, you will have to pay capital-gains taxes, but you’ll have more control over the timing of the sale, he says.
A cautionary note: Investors also should keep in mind that they’ll owe tax on the IRA distribution anyway. So, an in-kind withdrawal just means the cash to pay the tax has to come from somewhere else.
One bright spot in a down market: If you sell investments at a loss, you can use those losses to oﬀset capital-gains taxes on other assets you sell, Baird’s Mr. Steﬀen says.
4. Take time to balance
Some investors lulled by rising markets might be out of practice in this area, but experts remind everyone that to survive a down market it pays to have balanced portfolio allocations of equities, ﬁxed income and other asset classes. Investors who kept a portion of their portfolios in ﬁxed income as the stock market was rising were happy in October, November and December, says Mr. Cox.
“If people have the right level in the stock market to begin with,” says First Bank of Omaha’s Mr. Spieler, “the right question should be, ‘Should I be buying into this downturn?’ not, ‘Should I be selling?’ ”
The winning game plan, experts say, is exactly the same in an upward-bound market as in a downward-trending one. If you stick to your asset allocations and don’t sell too soon, you will likely come out ﬁne in the long term. “High-quality investments, properly diversiﬁed, reinvesting dividends: that’s proven over time to be a successful investment strategy,” Mr. Pennino says.
Source: Chana R. Schoenberger, Feb. 3, 2019