Be Savvy
Beyond the basics, a smart investor can employ a variety of strategies to
cope with adverse market conditions. Give some of these strategies a try:
- Pay down debt. The return on investment by paying off a loan is equal
to the interest rate charged — but unlike other investments, the return
is guaranteed. Even paying down a mortgage (often considered good
debt) may be the best investment you can make in a down market.
- Invest for total return (the combination of growth and income), not
just income. Down markets often coincide with sluggish economic conditions.
Income investors feel the squeeze when rates on CDs and other
income investments drift lower and lower. Invest for the highest total
return consistent with your risk tolerance and then take distributions as
needed.
- Continue to invest the same amount of money on a consistent basis,
be it weekly, monthly, or quarterly. By sticking with the program in
good times and bad, and increasing the amounts of your contributions
when you can, you can build wealth regardless of market conditions.
- Automate your savings program. Participants in 401(k) plans enjoy
both automatic investing and dollar-cost averaging, but most financial
institutions will arrange similar systematic investing in other types of
accounts.
- Use target maturity and life-cycle funds. These funds-of-funds provide a
complete portfolio rebalanced automatically, ensuring broad diversification
and effortless investing.
Take Advantage of the Turmoil
You can’t control what happens in the markets, but you can turn market
turbulence into opportunities. Consider actions like these during market
declines:
- Buy more. A decline in prices means investments are on sale. If you’re
saving and adding to your accounts, you should be delighted with a
down market. You want the value of your holdings to be higher when
you retire or when you need them — it doesn’t matter so much what
they’re worth now.
- Rebalance your portfolio at least annually. Market declines can cause
your allocations to stray far from your target. To get your portfolio back
in line, you buy what’s gone down and sell what’s gone up. Buy low, sell
high.
- Harvest your tax losses. Tax-loss harvesting (selling assets in which you
have a taxable loss and replacing them with other nearly identical securities)
is a great and legal way to take advantage of the tax code. Just be
careful to avoid wash sales — basically, the IRS will disallow your loss if
you buy back the same security within 30 days of selling it. This includes
mutual funds. You can, however, buy similar mutual funds; for example,
if you sell a large cap value fund, you can buy another large value fund
immediately, as long as it isn’t the same fund you just sold.
- Convert traditional IRAs to Roth IRAs. When you convert from a traditional
IRA to a Roth IRA you must pay the income taxes now. But you
won’t owe taxes later. If converting to a Roth is beneficial for you, it
makes sense to do it when the account balance is lower because your
immediate tax bill will be lower.
Don’t fixate on income taxes. Fear of paying taxes has prevented more people
from taking necessary actions than just about any other reason. If your analysis
suggests that selling is required, don’t let the tax consequences stand in
the way. Besides, with special rates for long-term capital gains, the tax bill may
be lower than you think.
