For long-term investors following a disciplined investment strategy, a market downturn usually is really not much different than other points along your investment journey. You should continue to prioritize your future goals, while considering how the decisions you’re making today can benefit your future self.
That being said, some investors find a market downturn an exciting opportunity to make more headway in their growth goals—even as their portfolio’s valuation declines. Here are three tips for helping to make the most of a market downturn, plus a few reminders for those who are feeling anxious about facing a big ‘ol bear (market, that is) head on.
Consider a Roth conversion
Did you know you could potentially get a little more bang for your tax buck if you opt for a Roth conversion during a period of poor market performance?
Before we explain, let’s back up for a minute.
If you’ve been growing your retirement savings in an employer-sponsored retirement plan like a 401(k) or 403(b), you’re likely familiar with some of the benefits of doing so. Anything contributed to the account (up to the annual contribution limit) is immediately deducted from your taxable income. Another benefit? Investments and savings within the account grow over time, but you aren’t responsible for paying taxes on the earnings until you make a withdrawal—which is intended to be in retirement. The same principles apply to a traditional IRA.
While these tax-deferred accounts offer upfront tax savings, they do create taxable income once retirement hits—and who knows what your tax rate will be when the time comes to make withdrawals (especially if you’re still several decades out).
Enter: Roth conversions.
With a Roth conversion, you may have the opportunity to transition all or a portion of your tax-deferred 401(k) or IRA into a Roth account. You’ll pay tax on the principal amount and any growth that’s already occurred up to that point. The trade-off here is future qualified withdrawals are tax free.
But what does this have to do with a market downturn?
During a market downturn, your portfolio’s value may drop. Let’s say prior to a downturn your IRA was worth $200,000, but recently it’s dipped down to $150,000. Now, if you choose to do a Roth conversion, you’re paying taxes on a portfolio valued at $50,000 less than it previously was (assuming you’re converting the entire amount). Not only are you creating future tax-free income for retirement, but you’re potentially paying less in taxes because of the market downturn.
Keep in mind that you still hold all your positions and investments during a Roth conversion. You aren’t selling off stocks at a loss, unless you plan to use them to cover the tax liability. You’re simply transferring them from one type of retirement account to another.
A Roth conversion can be an effective method for diversifying your retirement income. However, it’s not for everyone. First, if you anticipate being in a much lower tax bracket in retirement, even a market downturn may not be enough to justify the tax liability it would create today.
And second, you’ll only experience the full benefits of a Roth account if you meet the criteria for taking qualified (aka, tax-free) withdrawals. According to the IRS, withdrawals are considered qualified as long as:1
- It’s been at least five years since the first contribution was made, and
- You’re at least 59.5.
Those who are disabled or who inherited the account can also make tax-free withdrawals if they’re under age 59.5, as long as the account has met the five-year holding period.
Invest at a “discount”
When a stock’s price drops as a result of a market downturn, you can spend the same amount as you would have before the drop and scoop up more. For example, if you have $500 to invest and shares of a stock are $100, you can purchase five shares each. But if their valuation drops to $50 a share, now you can purchase twice as many for the same amount of money.
Think of Warren Buffet’s famous words of wisdom, “Be fearful when others are greedy and to be greedy only when others are fearful.”
The key? Invest only what you can afford to lose. While the cyclical nature of the markets tells investors a correction or upswing may be coming, there’s no guarantee that the individual stocks you’re buying for a lower-than-usual cost will recover. Future results are never guaranteed. Investing always involves risk, even though the historically cyclical nature may give investors an idea of what could be coming next.
A word of caution: Don’t consider this strategy a stock-grabbing free-for-all. You’ll still want to do your research and find equities that align with your goals and investment strategy. Consider it your opportunity to buy stocks that are normally valued higher at a possible “discount,” as opposed to buying up every stock that’s dropped in value. Some stocks perform poorly because of external factors (poor reputation or scandal, government policy, economic variables, etc.), while others may simply be undervalued now due to the general market downturn. This strategy aims to identify the latter.
Stay the course
Until you actually sell off an investment that’s dropped in value, you haven’t experienced a loss.
If you bought 20 shares of a tech company’s stock before the market drop, you still have those 20 shares today (even if they’re valued for less than you bought them). Rather, you’ve only seen your portfolio’s value drop—but those losses aren’t locked in until you sell. So perhaps one of the most impactful things you can do during a market downturn could be to simply leave your portfolio right where it is and give it the time needed to recover and grow.
Feeling panicky? Two tips for staying calm in a bear market
So far, we’ve focused on how to leverage a market downturn to potentially expedite your portfolio’s growth goals. But when it comes to navigating bear markets and downturns (or nosedives, as the case may sometimes be), it’s important to acknowledge that this can be a scary time for many investors. If you’re on the fence about forging ahead and facing a big scary bear, here are two things to keep in mind.
#1: Follow the market cycle
The stock market has historically been cyclical in nature—and it has been for over 100 years. Of course, it can be hard to see the forest through the trees when your portfolio’s down and the headlines warn of persistent doom and gloom. Future performance is never guaranteed.
But eventually, we believe a market downturn is likely to be followed by an upswing—the tricky part (especially for those nearing retirement) is that we don’t know when that will happen. Bear markets have lasted in the past on average around 289 days, or nine and a half months, though there have certainly been exceptions. For example, the 2020 bear market lasted only 33 days, while the oil crisis bear market of 1973–1974 lasted 630 days.2
Because no one can predict when a bear market will begin or end, investors need to incorporate protection strategies, like diversification, into their portfolio. This becomes increasingly critical as you near retirement, but at any time along your wealth-building journey, diversifying your assets can be the key to sustaining your portfolio through prolonged periods of market volatility.
#2: Consider your tolerance for risk
Before making changes to your portfolio during a market downturn, consider what your appetite for risk really is.
Are you able to handle short-term losses, or does a downturn trigger a heightened emotional response that’s hard to ignore? Risk tolerance goes beyond quantitative factors like age and net worth, as it also depends on your level of comfort with experiencing what may or may not be temporary losses and the emotional or mental impact that may cause.
Just because stocks may be valued lower than usual during a downturn doesn’t mean you should ignore your risk tolerance.
During short-term volatility, think about the long term
There is a difference between making strategic moves during a market downturn and acting impulsively out of emotions like fear, greed, or anxiety. Think about how you can use this as an opportunity to address the goals you already have in mind, such as diversifying your future income for retirement or reducing concentrated positions within your portfolio.
With a disciplined approach and focused strategy, you may be able to use a sudden downturn or bear market to your advantage. Just be mindful about your long-term investment strategy, and focus on making decisions that align with your goals—as opposed to acting on impulse or emotions. By using the market cycles to your advantage, you may have the potential to expedite your portfolio’s growth and mitigate some long-term general tax liability.
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