Stock market investors this month endured their first sizable decline since the early days of the pandemic, and most heard a familiar refrain from advisers, investment firms, the financial media and others:
Don’t do much of anything.
That’s generally good advice, as it can keep investors from making drastic shifts that they might regret later. Timing the market isn’t easy.
But some actions might be warranted during times of investment turbulence, especially if you haven’t paid much attention to your portfolio lately. Here are some of them.
Re-assess your tolerance for risk
Buy and hold investing is a historically wise strategy, but it rests on the assumption that you can stomach and wait out the downdrafts. Many people can’t. The stock market’s bumpy start to 2022 provides a useful litmus test.
If you’re having trouble handling the stress, it might be wise to alter your investment mix, possibly trimming some of the more volatile holdings, especially if they’re concentrated in a few areas such as technology stocks or tech funds.
Then again, you might want to add more money to hard hit areas. Rebalancing is the strategy of setting a target investment mix and adjusting back to that framework when holdings rise or fall sharply. It basically means taking some profits in stocks or funds that have fared relatively well and reinvesting the proceeds in laggards.
Your capacity to tolerate paper losses might be greater than you realize, especially if you have near-term spending needs covered, debts under control and steady job prospects. You might even start regarding Social Security retirement benefits or employer-provided pensions as part of your portfolio.
These assets essentially act as highly secure annuities that help to stabilize your finances, though most people probably don’t view them as part of their investment mix.
Look to other investment possibilities
Sharp market declines often mark turning points when certain types of investments rotate out of favor and others take their place. Technological innovation is here to stay, but too much of the recent speculative action was centered here. It thus might be a good opportunity to shift some of your assets to other areas. For example, value stocks could offer a more stable ride in a possible slowing economic climate, and stocks in many foreign countries have lower valuations than their U.S. counterparts.
“We do still see the U.S. in a mid-cycle expansion,” with no recession sight, said Lars Schuster, an institutional portfolio manager at Fidelity Investments. But many Eurozone countries are earlier in the business cycle, which could make companies focused in these areas relatively more attractive, he added.
Bonds also have sidestepped much of the speculative fervor of late. However, bond prices will stumble if interest rates rise significantly. As such, it might be premature to shift into the fixed-income area. But eventually, bond yields will move higher, providing investors with juicier cash flows.
Making gradual portfolio adjustments following sharp market declines, or rallies, is what rebalancing is all about.
Consider tax-related selling
Taxes are another consideration that might prompt you to sell, or avoid selling. If your investments are held in Individual Retirement Accounts, workplace 401(k) plans and other tax-sheltered vehicles, you don’t need to worry about taxes. Trading within these accounts doesn’t trigger tax consequences. But other transactions might.
In general, if you sell stocks, mutual funds or other securities at a loss, you typically can use those losses to offset taxes on any gains you realized. If you have losses beyond that, you can deduct up to $3,000 annually against regular income and carry forward unused amounts.
Deductible losses thus can help to cushion modest market blows, while the taxable gains that might result from knee-jerk selling can work to your disfavor. On assets held more than a year, gains are considered long term, on which most people pay a rate of 15%. But on short-term profits, most investors would pay taxes at ordinary-income rates, which likely would be higher.
And there are other tax moves to consider. If you have money in a traditional IRA, for example, you might want to transfer some or all of it to a Roth IRA. You would need to pay taxes on the value of the assets you move, but future withdrawals from the Roth would be tax-free. Roth conversions aren’t for everyone, but they can make more sense following a market reversal.
The point is that several tax ramifications, good or bad, are in play, and might justify some selling following market downdrafts.
Heed the historical record
Buy and hold investing doesn’t appeal to everyone, but it typically has worked. The stock market historically has spent most of its time rising rather than falling, and it usually hits a new high with each recovery. That can’t be said about individual stocks, which can crash and burn and never bounce back. But it does hold for the overall market and broadly diversified portfolios such as mutual and exchange traded funds.
Downdrafts aren’t pleasant. They’re scary, and each one seems driven by unique factors. Yet certain patterns recur. Corrections — declines of 10% or more — happen nearly once a year on average, though not on a set schedule. They help to release speculative steam.
“Corrections do happen. They should happen. They’re healthy in many ways,” said Jurrien Timmer, Fidelity’s director of global macro.
Stock prices rebound, too. Following the past 32 corrections dating to 1980, the S&P 500 was up on 29 occasions 12 months after hitting the lows, logging a median gain of 25.9%, according to Savant Wealth Management. The median decline was 16.5%.
Another historical reality is that higher inflation and interest rates don’t typically derail stock prices and the economy. Over the past several decades, “There were only a couple instances when a Fed hiking cycle was bad for the markets,” said Schuster, citing those tied to the 1970s Arab oil embargo as the exceptions.
Rate hikes usually aim to keep economic expansions under control.
“The reason we’re hiking is that the economy is growing,” Schuster said. Even now, he said, corporate profits are still rising, unemployment is declining and banks remain eager to lend.
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This article originally appeared on Arizona Republic: What you can do as the stock market remains volatile