Why You Shouldn't Fear a Bear Market
As long-term investors, we experience many extraordinary financial climates. Whether it be bear stock markets, high inflation, unstable bond values, or the union of all three, there are countless questions revolving around society’s short-term economic outlook. It is difficult to navigate this turmoil with never-ending articles and posts justifying your fear. How far will the market drop? How high will the inflation rate soar? Will there be a recession? It is perfectly rational to see investing as an impossible venture as we are constantly battling unique anomalies. However, the best way to combat uncertainty is to understand three principles for successful investing. A principle is something that is always true, despite external circumstances and when followed correctly, these practices separate the great investors from the good ones. Sticking to the fundamental principles of proper education, emotional discipline, and time will anchor your reactions when the going gets tough, deterring any costly mistakes.
EDUCATION - CREATE AND FOLLOW A FINANCIAL PLAN
“By failing to prepare, you are preparing to fail.” – Benjamin Franklin
Life is an ever-changing maze, and a financial plan simply provides a pathway through it. At Divergent Wealth, we believe that financial planning is not a one-time occurrence. As your life changes, your financial plan can change to achieve the goals you desire. A proper plan can account for the events that often make us pump the brakes and reassess. By building a plan around a pessimistic environment, our clients have confidence that their plan will survive the most extreme economic events including hyperinflation and prolonged market downturns. If you have worried about your goals during the recent economic volatility, financial planning may provide the security you need to get through uncertain times.
EMOTIONAL DISCIPLINE - RECOGNIZE AND REACT
“In investing, what is comfortable is rarely profitable.” – Robert D. Arnott
Fear is natural. When the market declines, we may suspect total economic collapse is inevitable. As humans, we instinctively look for ways to stop the bleeding. Many investors turn to pulling out of the market and selling their equity. Others may turn to more conservative investment vehicles or seek haven in gold and other commodities. Pulling out of the market as it declines results in selling at a loss, taking your assets out of the workforce, and depriving it of any chance of recovery. This emotional response is perfectly rational but one of the ultimate enemies of investment success. To master this reaction, you must anchor yourself to a reliable investment strategy and sound financial plan.
The market is consistently facing multiple geopolitical and economic events that could justify a drastic downturn. However, through each of these events, the S&P 500 has recovered in the long term. The graph below demonstrates the necessity of maintaining a long-term outlook in your investment strategy. There are plenty of justifiable reasons to sell but in the long term, the market recovers.
Figure one: “Resilience of the U.S Stock Market” 1936-2020 (Financial Samurai, Geopolitical Risk, and Stock Returns, 2022)
In times of market crisis, it may appear that there is no end in sight, but it is crucial to remember that there is light at the end of the tunnel. The eventual recovery provides investors with confidence and stability during the volatility.
TIME - EMBRACE VOLATILITY AND TAKE ADVANTAGE OF IT
“If you aren’t thinking of owning a stock for 10 years, don’t even think about owning it for 10 minutes” – Warren Buffett
History is our best teacher. It has repeatedly been proven that volatility is inevitable, and the market eventually recovers. Human beings are wired to panic during instability, but by understanding the market’s long-term restoration, investors can learn to embrace volatility. An investment strategy should plan for and take advantage of short-term swings. After all, how sound is a plan if it does not account for the unexpected?
Succumbing to your emotions and pulling out of the market can be costly. The graph below demonstrates that if you missed the market’s 30 best trading days in the last 30 years, your return was 83% less than what it would have been had you stayed invested. Just 30 out of 10,000+ days! The graph on the left shows that most of the best days occurred during a bear market when investor speculation is at its highest. It is impossible to pinpoint when those 30 days are going to be. Time in the market is the only sure way that an investor can capture each trading day.
Figure two: “Timing the Market is Impossible” (Hartford Funds, Timing the Market is Impossible Brochure, 2021)
Now, what not to do is only half of the equation. What things can we do to take full advantage of a market downturn? STRATEGIZE – ACTION ITEMS TO CONSIDER
I believe each investor eventually reaches a point in their lives where they feel the need to include a co-pilot who will help them make the best decisions with their money. A financial planner’s whole job is to align your assets with your goals. Simple as that. This includes when the market is contracting, and it seems like your money is working against you. With the correct strategies, your capital can be working in your favor, despite the anxiety of the ongoing economic issues. The following are some strategies to consider deploying while working with a financial professional.
Increase Retirement and HSA Contributions
Though markets can be erratic, your retirement savings goals should remain undeterred. Understanding the market helps investors embrace the volatility. Our natural emotional response to the market dropping is to stop all savings. This is wrong. If you can, you should consider increasing your retirement savings, you are reaping the benefit of cheaper prices and eventual growth! Who says no to a good sale? Any assets in your tax-advantaged accounts are generally considered long-term money. If you use market volatility to your advantage now, you will appreciate it later down the road.
Roth Conversions
The benefit of tax-free growth is hard to pass on. Roth IRAs were designed to allocate funds that you pay taxes on in the year you contribute, with the intention of distributing the future growth completely tax-free in retirement. This benefit is so desirable, the law limits who can make Roth IRA contributions based on annual income ($144,000 for single filers and $214,000 for married couples filing jointly). However, there are still ways you can place assets into a Roth IRA for that eventual tax-free growth, even if you exceed the income limits.
A down market presents a great opportunity for buying equity at a discount, as I mentioned before. This benefit can be added upon by investing in a Roth IRA, capitalizing on the eventual recovery and growth. A Roth conversion is when assets from your tax-deferred accounts such as your Traditional/Rollover IRA or 401(k), are transferred to your tax-free Roth IRA. Now, all that growth in the Roth IRA can be completely tax-free when you need to take it out in retirement.
The consideration here is that income taxes will be due on the amount converted. Working with a financial planner or CPA can help you navigate this strategy. If it makes sense for your situation, deploying a Roth conversion game plan is a great long-term benefit.
Tax Loss Harvesting
It has been clear that you can train your emotions to not react with fear during extreme market conditions. I may sound crazy if I say that you can also look at the losses in your account as a good thing as well.
You see, losses in your account can be taken (harvested) and be used to offset any of the gains that you have in the account, saving you capital gain taxes due. Not only that, but you may even use a portion to offset some income. When the market is down, it is a great time to analyze your portfolio, and determine if it makes sense to realize losses and make them work for you.
In conclusion, investing does not need to be complicated. The formula of proper education, emotional management, and time equals investment success and confidence in the future. Market declines and recessions are a part of the business cycle. This isn’t our first rodeo, and it won’t be the last! Speculation and fear come together with market irregularities, but with adequate financial planning, you can learn to work volatility in your favor. If you would like an in-depth review of your financial plan or to talk through your investment strategy, contact us at Divergent Wealth. We are happy and able to provide a complimentary consultation and continue to earn your trust as your family CFO.
EASTON DICKSON, CRPC®
DIVERGENT WEALTH IS AN INDEPENDENT RIA FIRM IN THE SALT LAKE AREA THAT PROVIDES COMPREHENSIVE FINANCIAL PLANNING RELATING TO RETIREMENT PLANNING, ASSET MANAGEMENT, ESTATE, AND TAX PLANNING, INSURANCE, AND EDUCATION FUNDING.
Citations
Figure one: How does geopolitical risk affect stock prices? Financial Samurai. (2022, February 14). Retrieved July 25, 2022, from https://www.financialsamurai.com/geopolitical-risk-affect-stock-prices/
Figure two: Timing the market is impossible. Hartford Funds. (2021, October 3). Retrieved June 13, 2022, from https://www.hartfordfunds.com/practice-management/client-conversations/timing-the-market-is-impossible.html
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