Help!!! The Market is Going Down…What Do I do?


More often than not, I encounter many an investor putting their hard earned money in the market with the “hold and pray” strategy. “Oh, I’ve been taught to just buy and hold, and hope I can stomach this roller coaster of a ride.”

Unfortunately, more often than not, too many bail out, committing the Cardinal sin of investing, buying high and selling at lows.  As I write this post,  it is July 2015. The last 4-5 years of the stock market greeted us with very little volatility, which can deceptively lull us into complacency and inaction; until that is, volatility roars with intense ferocity of a Cat 5 hurricane.  Suddenly, investing wasn’t as easy as it was before.

Many investment gurus tout the coming of a correction, and others make arguments that we still have room for growth, and you know what, THEY ARE BOTH RIGHT!  When an analyst predict a coming correction, they will eventually be proven right (vice versa).  It is just a matter of time, yet they are credited with omnipotent powers of prediction rivaling that of the Messiah. What would impress me if they can predict this over and over again?  Come to think of it, they sell this load of !@$^ in the form of monthly paid newsletters which makes me scratch my head…why don’t they just invest in strategies to take advantage of  their predictive powers? That would be an easier way to make money. Sorry to digress…I will get off this soap box.

We know of 3 things. (1) The market will go down (they usually correct every 18 months (correction=10% decline or more), sorry for all of these parentheses) (2) The market will go up (3) The market will be flat with little volatility.  It will do all of three of these, yet, most investors only have a strategy for the market going up, not going down.

So What Should I do?

The asset vehicle is key.  What do I mean by this? We have seen more than 100 market corrections since the 1920s and I would like to ask you how many market recoveries have we seen from these corrections? What was that you say? ALL MARKET CORRECTION RESULTED IN RECOVERIES?  You are absolutely correct.  All market corrections eventually lead to market recoveries 100% of the time. Keep in mind I use the term “market” vs. stock or vs. an industry or sector.  There has been precedence where companies or an industry do not recover…can you think of any (ahem…Lehman, Bear Stearns, Enron, ahem…) So what’s my point? It is this.  I hope and pray that you have conviction in your individual companies and sector specific investments you hold. Otherwise, take risk of the table and make it question not of what stock to buy, but what markets to invest in.

Ibbotson-SBBI-1926-2010

Using Indices

Now that we understand historical precedence, hopefully you now have confidence in our economy and market’s ability to rebound.  “But this time it’s different…” Oh boy, I have heard this the last 19 years of my career.  Famed investor, Sir Jon Templeton was actually quoted as saying “The four most expensive words in the English language are: “This time it’s different.””  Did I just digress again…sorry…these are just very common conversations I have with investors and I want to provide differing perspective from different angles.

Now that it is about investing in “markets”, vs. specific sectors and stocks that differentiate investors from “speculators” (at least for most folks), it is important to understand the behavior of these different asset classes (markets).

callan-2014-periodic-table-of-investment-returns

This is the Callan Periodic Table of Investment Returns (Top row is best performing investment for the year, bottom is worst). If you can develop an algorithm or pattern to predict the best and worst performing investments each year, I will be the first to nominate you for the Noble Prize in Finance. Unfortunately, none yet has been developed.  An important idea to take from this chart is that different markets/assets behave differently over time, but they all will give you profit.  You want to take advantage of this notion the following way.

Art of Rebalancing

So easy to say…so hard to do? Why? We are not behaviorally wired to do this.  We have a section in the brain that houses emotions of fear, greed, and pain that did not progress in development over time.  These emotions, unfortunately, manifests itself in bad investment decisions.  Do you remember back in November of 2007? I do. The markets were at new highs and during conversations with clients and having brought up the idea of rebalancing (selling stock to take profits); I was met with puzzled, startled in disbelief…GLARES! “Are you kidding? Let it ride man!”  You know where that led.  If you think that was bad, guess what kind of reaction I was met when I suggested to rebalance and buy more in March 2009, the abyss of the market? No need to describe the reaction…

Because we know that market corrections give way to recoveries, what we need to do is take advantage of these opportunities to buy more.  Yes, tough to do, we don’t like seeing money vaporize; but when bond values are up during market down turns, then sell bonds to buy more stock at bargain basement prices.  The markets have always historically recovered. “But this time it’s different”- HAH! Take advantage of the behavior of various asset classes and use it as a strategy when the markets pull back

Something out of Nothing

There is another post that talks about the importance of investing in different accounts (IRAs/401ks, Taxable Account and Roth IRAs).  There is actually a way to make something out of nothing with investments in taxable accounts.  What is this? Hocus Pocus? Let’s take a look at the S&P 500 during that volatile time in October 2014.

tax loss

Investing in September 2014 would have led to a rocky, roller coaster ride.  Let’s just say that during this period of time, we invested 100K in the S&P 500 and lost over 7% or $7000! Looking at this chart, easy to see that the right thing to do was to hold it, and in fact, everything would have been ok and then some! Well…isn’t this what you are advocating? No, remember there are some advantages of investing in taxable accounts, one of which is Active Tax Loss Harvesting. What if we sold the S&P 500 with a $7,000 Loss what will that do for me? (Keep in mind that you never invest with the intent to lose money; that is never a winning proposition.  What are aiming to do is acknowledge that short term volatility is not in our control.  Rather, we take advantage of asset classes going down and turn lemons into lemonade (sorry for that saying…))

Pocket Value of Tax Loss Harvesting

With this 7K in tax loss assets, we can use to take 3K against our income per year (the IRS allows us to use $3,000 in losses against our income per year, and roll forward any excess losses indefinitely to future years), or use it dollar for dollar against any gains. What does this mean to your bottom line?  If we are in a combined 35% Fed and State tax bracket, that $3000 in losses (3000*0.35) will result in tax savings (keep it in your pocket of $1050) of $1050!.  On your original investment of $100,000, that is a net 1.05% return…not bad making something out of nothing.

 

Wait a Minute…Look at the Chart…I would have lost out on the gains

Ok, wow you are observant.  Here is the key to successful tax loss harvesting: you have to keep it performance neutral (no market timing!).  Let’s say we reinvest the tax loss proceeds in an investment highly correlated to the S&P 500, let’s say the Russell 1000. Here’s the chart:

tax loss 2

Your investment portfolio participated in the “rubber band” recovery of the market through the rest of 2014! Yet, you still have this tax asset. Well…I am just deferring the tax at a later date?!? WOW! Great job catching this observation.  Take a look at the Callan Chart again above.  Imagine doing this strategy for multiple different asset classes with multiple lots of those investments.  You have an infinite amount of possibilities to do this going forward. Also keep in mind, you are not able to remain performance neutral if you use individual stock (Coke and Pepsi are still 2 fundamentally different companies); advantage broad based indices.

In Conclusion

Have a concrete strategy for all market scenarios. Don’t invest, hope and pray. Have the wisdom to understand what is in your control and what is uncontrollable.  Have an action plan!

EMPOWER YOURSELF!

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