Although we are not technically in a bear market (the S&P 500 Index has not declined 20%) it absolutely feels like one. The tech-heavy NASDAQ index is 26% off its highs, and so are small-cap stocks. Many of the darling stocks of the latest growth rally have been decimated. These are some of the most widely held names among individual investors. Amazon is down 41%, Netflix a whopping 73%, Facebook is down 47%, and Nvidia is 48% off its highs. So far, Apple, Microsoft, and Google are holding up better. They are all down between 20-23% from their highs.
The most important thing right now is not to panic and to stick to your plan, assuming you had one. But every market environment presents an opportunity to do something to improve your portfolio or your total financial picture. These actions can help scratch the urge to DO SOMETHING to ease the pain of seeing red on your statements. It is in our human nature to react to fear, and with careful planning and deliberation, perhaps we can harness that energy into something productive rather than destructive.
I call this the bear market playbook.
It sounds so simple. Rebalance your portfolio. This only works, of course, if you had a target allocation before the downturn. It’s not too late to develop a target portfolio either. If stocks are supposed to make up 80% of your portfolio, and today they are 75%, you can buy more stocks by selling bonds and /or investing cash that was sitting on the sidelines. One of the unfortunate circumstances in this selloff is that both stocks and bonds are down this year. This makes rebalancing tougher than in typical bear markets. Perhaps you have a long commodities allocation that is way up. Reap your winnings to sow seeds for the next uptick in stocks. It feels counterintuitive, and you won’t want to sell some of your winners. But, over time, rebalancing is the only way to buy low and sell high without guessing. Yes, stocks may go down further from here, but the beauty of long-term investing is that you don’t have to time it perfectly.
Take Tax Losses
Some of your holdings may be below your original purchase price. By selling these positions, you book a tax loss that can be used to offset capital gains either this year or any year in the future. You will have to get over your Get-Even-Itis to embark on this accounting strategy, and you cannot buy the same security back within 31 days to avoid running afoul of the IRS wash sale rule. But, you can reinvest the cash into something similar and maintain your asset allocation. For example, you could sell Netflix, Facebook, and Amazon and purchase the QQQs (the Invesco ETF linked to the NASDAQ 100). For the first time in a while, you have the opportunity to take tax losses in bonds and bond funds. Your tax losses are an asset. You will use them in the future to reduce your capital gains tax. Harvest them.
ROTH IRA Conversions
If you are considering converting IRA assets to a ROTH IRA, the conditions are more favorable with the market down. This is because the tax owed on a ROTH conversion is calculated based on the value of the IRA on the date of the conversion. In other words, an IRA worth $1M at year-end, could be worth $800,000 today. The tax bill is much lower today than it was 5 months ago. Ideally, the new ROTH will participate in the market’s recovery, resulting in a larger ROTH with less tax paid.
GRATs – Grantor Retained Annuity Trusts
TLDR: wealthy families can transfer assets to the next generation in a complicated but tax-efficient manner.
Some estate planning techniques are more optimal during bear markets. One of these is the use of grantor retained annuity trusts or GRATs. With a GRAT, the donor placing assets in a trust agrees to receive a series of annuity payments equal to the current value of those assets over several years, and the remaining assets in the trust transfer to its beneficiary(ies) without the use of annual of lifetime gift exclusions. Making GRATs even more attractive is that the interest rate used to calculate those annuity payments remains historically low. This means that less money has to be paid back to the GRATs creator in the form of those annuity payments and more assets remain in the trust to grow and leave excess returns to the beneficiary.
Accelerate Family Gifts
You don’t need a complicated trust structure like a GRAT to pass assets on to family members. You may choose to give cash that can be invested or securities likely to appreciate soon instead. Consider accelerating gifts to 529 college savings plans, UTMAs, or any other form of family gift now, while the market is down. Once invested, these gifts have a higher expected return today, simply as a function of lower stock prices.
Just Keep Buying
My colleague Nick Maggiulli wrote an excellent book on saving and investing called Just Keep Buying. I can’t get his recommendations out of my head. This might mean investing that slug of cash you had sitting on the sidelines last year because “the market was too high”. Well, what are you waiting for? Here’s your chance to buy stocks on sale. I am not predicting a fast, V-shaped recovery like the Covid crash in 2020, but there is no guarantee that stock prices will be lower tomorrow or at any time in the future. If your time horizon is 5 or more years from now, there’s no reason to wait. Take the bird in the hand and invest. When in doubt, Just Keep Buying income-producing assets.
This is just a shortlist of ideas that came to mind when I was brainstorming about a bear market playbook. To be a long-term investor is to be an optimist. I always try to look for opportunities and lights at the end of the tunnel. Think of this market as an opportunity to tune up your portfolio and your financial plan.