Stock market downturns are never welcomed, but they are inevitable. Even the most sophisticated investors can’t predict when they will occur or how long they will last. But, if there is any comfort to be found as stock prices come crashing down around you, it’s that if you don’t sell it, you haven’t lost it. It should also comfort you to know that all bear markets are followed by a longer-lasting bull market. Historically, bull markets have not only erased the losses of a bear market, but they have always taken the stock market to new highs.
Long-term investors who understand that down markets are only a temporary interruption of a more enduring market advance are less likely to follow the panicky herd over the cliff, which will undoubtedly result in permanent losses. Instead, they know how to look for opportunities to enhance their investment performance and boost their wealth-building capacity.
Here are five investment strategies that investors can use during market downturns to boost their long-term prospects:
Stay Invested
If you have a sound investing strategy, there’s no reason to abandon it during a market downturn. The long-term returns you projected for your strategy already account for potential market downturns, which can happen with some regularity. Trying to time the market almost never works to your advantage, especially when emotion is driving the action. Think about the investors who fled the market in March 2020 when the S&P 500 crashed more than 30%. By summer, the market had erased its losses and went on to gain 65% from the market bottom.
The real trouble with trying to avoid market downturns is the biggest gains in the market tend to occur close to the biggest declines. If you miss the best return days of the market, your investment will invariably underperform.
Go Bargain Hunting
Many market downturns have a tendency to accelerate, often driven by panic or speculators who must abandon their positions due to margin calls. This overreaction can lead to the significant undervaluation of securities. That creates opportunities for savvy investors to buy stocks at steep discounts. When you can buy stocks or add to your existing positions at a discount, it lowers your downside risk while increasing your upside potential.
Dollar-Cost Average
Dollar-cost averaging consists of investing a fixed dollar amount each month. The funds can be allocated across securities in your portfolio that match your risk-return profile. When the price of those securities fall, that fixed dollar amount buys more shares. When the price increases, it purchases fewer shares..
In a declining market, your fixed investment amount will continue to purchase a higher number of shares at lower prices. If you believe that stock prices will continue to rise in the long-term, just as they have over the last 125 years, you can expect that the average cost of your shares at any given time will always be lower than the prevailing share price.
Tax Loss Harvesting
Tax-loss harvesting is the process of selling securities that have lost value to generate a capital loss which can be used to offset any gains or income generated throughout the year. You are allowed to use up to $3,000 of losses to offset ordinary income each year, which can reduce your tax liability. If your losses are more than $3,000, you can carry them forward to future years.
If you take a loss on a stock that you still want to own, you will need to wait 31 days to repurchase it to avoid the IRS wash sale rule. If you can repurchase the stock at the same or lower price, you can reap the tax benefit of the loss while maintaining the investment’s long-term growth potential.
Roth Conversion
If you have been considering a Roth conversion—transferring funds from a traditional taxable IRA to a tax-free Roth IRA—you would be better off doing so during a market downturn. Why? A Roth conversion results in an immediate tax on the funds being transferred. By waiting until stock prices decline, you will pay fewer taxes. It’s always advisable to do a Roth conversion in a year when your income is lower than usual.
Any changes to your investment strategy, especially if they have tax implications, should be done under the guidance of a financial advisor who understands your circumstances, objectives, and risk profile.
