Things we can do while waiting for the economy to turn up.
When we’re faced with a dour financial forecast, we’re often told to batten down the hatches and stay the course. But what if the course we’re on isn’t all that great to begin with? Well for those of us who feel compelled to take action, there are ways to leverage this rocky and weak stock market.
A while ago, I wrote about why this stock market slump can be good for us and offered ways to survive a down market. Whenever we hit a rough patch of the economic cycle and the market deflates, I’ve trained myself to see the silver lining in it. Though I’m not an advocate of market timing, I believe that there are timely things we can do, depending on where we are in a market cycle.
Steps You Can Take To Leverage A Weak Market
So for those of us who can’t sit still, here are some things we can do to make the best out of a tough economic cycle:
#1 Consolidate and simplify your portfolio.
The market is down, which means you’re sitting on smaller profits. Now may be the perfect time to reduce the clutter in your portfolio. I am guilty of having a somewhat convoluted portfolio, having collected too many funds over the years. I’ve had a hard time consolidating them because I wanted to avoid tax hits on the accounts. Well, now that profits are smaller, it’s as good a time as any to consolidate and I’ll have less taxes to pay.
#2 Take advantage of tax write-offs by dumping losers.
Financial articles call this “harvesting your losers”. If you’ve been itching to dump poor performers in your portfolio, you’ve got a great excuse to do it now. When the market is doing well, you’ll probably see green numbers across the board and your weak performers may still be eking out gains, discouraging you from selling them then. But when you start seeing the “red”, you’re more likely ready to get rid of those weaklings. How it works:
- Ditch the losers to offset gains in your portfolio, then any losses left over can be deducted against other income such as salary or dividends, up to $3,000.
- If after doing the offset you still have remaining losses, carry over your losses into following years, while following the same rules (offset gains, then other income up to $3,000). As long as you still have losses, you can rinse and repeat this indefinitely each year and have your gains absorb your losses this way.
- Be wary of the wash sale rule if you decide to buy back your losing investments. That is, if you sell a stock or fund, you won’t be able to take a tax deduction if you buy the same type of investment within 30 days before or after your original sale.
#3 Do a Roth IRA conversion.
You may be considering converting your traditional IRA to a Roth IRA, a retirement vehicle that allows you to make after tax contributions into a tax free account. If your income isn’t over certain income restrictions (watch out for phase out rules for incomes over $100,000 for singles and $159,000 for married couples filing jointly), then you can do a conversion. But the conversion triggers some tax costs. You’ll pay taxes on your previously deducted traditional IRA contributions and on your IRA earnings; hence, it’s better that you do any conversion when your IRA accounts are on the low side.
I am strongly considering this move right now. Our income this year is quite low, while we haven’t qualified for tax deductible IRA contributions in the past. And the market is in the dumps, keeping our IRA earnings low with less to be taxed if we convert to Roth IRAs. Are the planets aligning for us to do this?
#4 Rebalance your portfolio.
Whenever drastic changes happen to our investments as is the case today, it may be time to revisit our portfolio to determine if we need to rebalance it and to ensure that we keep our allocations as they should be.
#5 Learn and accommodate hedging strategies.
No, I am not recommending you go out and short the market. That’s something that I’ve tried in the past with terrible results. I’ve learned my lesson the hard way: chasing returns in either direction is usually a bad move. But when times are bad, we learn how to become wiser and more resourceful about how to protect what we have. Because of fear of loss, we have more reason to evaluate hedging strategies such as the possibility of buying into annuities or including additional diversifiers in our portfolio (like currencies, commodities or REITs).
#6 Rethink your asset allocation.
With the negative returns we’re seeing, it may be worth our while to review the vulnerabilities in our portfolio and see where it can be improved. When the stock market is doing well, we don’t want to play with our allocations — even when we’re heavy on equities — because we’re enjoying the great returns. With down markets, our portfolio’s flaws are exposed and may need to be patched.
#7 Know where your financial institution stands.
How is your bank or mutual fund company holding up right now? Times like these may show the kinks in their armor. If your financial institution is in the FDIC’s troubled bank list, you may want to reevaluate your relationship with them. Some of them, like WaMu, may be on the line… so is WaMu’s free checking account with its current high rate worth the risk? Maybe, as this type of predicament can also spell opportunity.
#8 Improve your investment choices.
Take stock of how you’re doing and check to see if your holdings and positions are in line with their benchmarks. If they’re doing worse than the market, maybe you should look into alternatives that are doing better.
#9 Buy low.
I’ve said it time and again that difficult market conditions provide many opportunities to shrewd investors. If you buy when prices are down, you stand to gain so much more when the market rebounds. If you’re concerned about the volatility at this time, you can dip your toes into the market by using dollar cost averaging, value cost averaging or some other portfolio building techniques.
#10 Understand where you stand with risk.
This market will separate the wheat from the chaff (or chicken littles from the iron stomachs) as they say. One of the first things you determine as an investor is how well you (and your gut) can withstand market shifts. If you find yourself questioning your position as an investor, you can only thank this market cycle for helping you assess your taste for risk. It’s better to discover what your appetite for risk is today, than when a real big bear market hits.
#11 Teach yourself to be more frugal.
I can’t help but feel like I need to be more conservative and frugal about our money when our investments aren’t doing so well. The good thing about poor markets is that they afford us learning experiences that may very well turn us into better and more effective savers and investors in the long run. When times are tough, we become tougher — what doesn’t destroy us can only make us stronger.
#12 Rework your financial plan.
This is the time and opportunity to tweak and adjust a financial plan that is less than ideal. If there are holes in your financial plan, they’ll be easier to spot now!
#13 Train yourself to be less complacent and to be better prepared.
Use this period as a trial run for bigger things that can happen down the road. Let’s plan to be ready for anything!
#14 Test your current investment strategies.
Now that this economic downtrend has knocked the wind off your portfolio’s sails, are you still on track towards your financial goals? Should you stick to your guns or do you need to make adjustments to your investments in order to reach your objectives? This doesn’t mean we should attempt to make up for losses by taking on more risk; this simply means that we should assess what we’ve been doing so far to find out if we can make improvements to our investment approach. For instance, maybe buying penny stocks isn’t such a good idea after all!
It’s easy to feel anxious and uneasy when our portfolios are facing losses, and it’s very tempting to try to take action when things are happening outside of our control. But we should be careful that we don’t overdo things and try to do too much, as any actions we make may backfire on us if they’re not well analyzed or executed.
I look upon this situation as a way to become a wiser investor who refuses to let her emotions about the markets get the better of her. You can call this challenging financial period just another character-building moment for us long-term investors.
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I think I’ll be taking advantage of that $3000 loss rule this year… less for the tax man to take.
Taking advantages of losses is something I will be reading up on to make sure I fully understand the rules.
I’ve also heard of people trying to throw a bunch of money into the market when it drops significantly. This isn’t necessarily trying to time the market. You make your best guess as to when the market hits it’s bottom and invest some extra cash. Even if it isnt at the bottom, the market will most likely return to the previous high and surpass it at some point.
I’m with #9 all the way…i unfortunately don’t have the patience for the rest. So i just load up my 401k and roths while i can at low costs, and then max those babies out
i try to not load the stock ticker every day, but i get bored.
Great tips, its always great to see what other people recommend during these periods. I am thinking about dumping some of my low performers and now that I’ve read this I may actually do it.
Good set of tips. Now is a great opportunity for all who start investing.
Buy low (#9) and rebalance your portfolio (#4)
#6 re-evaluating your asset allocation based on a down market is a horrible idea, in my opinion. People have a tendency to freak out and sell at exactly the wrong time. It’s probably a really bad idea to change strategies under stress…
I recommend instead: #6 take a really big breath and repeat: “it’s only money, it’s only money…”
@Shadox,
I see where you are going with your comment. What I was trying to express with #6 (reevaluate your asset allocation) is that there are people who realize only after the down market hits that they are really in way over their heads. For example, someone who is in the cusp of retiring may still be heavily in equities. Because their (mostly) stock portfolio may be doing so well during the boom, they keep their allocation at 80% equities and 20% cash and bonds.
Then the market dives. All of a sudden, the soon-to-be retiree will need to scramble and give their portfolio a hard look. I’m not saying they should shift their allocations while the market is down based on how they’re feeling about things at this time. What I’m saying is that they should review their investments and think hard whether this is the kind of allocation they need going forward.
Unfortunately, they may discover a little bit too late that their allocation is not a match for their profile.
But they can only make improvements after they realize their situation and do that reevaluation. Executing these adjustments is another matter altogether though.
Of course, if you’ve got a solid asset allocation that you know suits you perfectly, then by all means — keep it! Stick to it and ride the bear out.
By the way, I’ve been enjoying some of the arguments made in these discussion threads lately. I like that I’m having to explain myself further, honestly!
It gives me some food for thought when you guys point out areas that need clarification or further explanation. Thank you for that! Also, if I’m inaccurate about anything, I welcome and am thankful for your corrections.
Number 13 is a wonderful tip. It’s simple, but I feel when practiced it can really help a lot. Thanks for a great post!
I lost a lot of money in stocks, now searching blogs for help and experience, your blog is very much helping.
I agree with the comment above about not selling current losers. You should always evaluate your asset allocation, at least yearly, but don’t look in terms of performance or return over the last year. You should evaluate your diversification, weightings, and expectations for the future. For example, look at your target weightings for bonds and expectations for the future. You are probably overweighted at the moment since equities are down and interest rates are low, causing a higher NAV for bond funds. Interest rates have a very high chance, say >90% of increasing over the next year or two. Good time to rebalance into equities. Take the profit in some of the bonds. In a year’s time (after interest rates have gone up), it may be prudent to rebalance again and buy those cheaper bond funds with a higher yield.
Similarly, evaluate individual stocks on their outlook for the future, whether you lost or made money on them in the past. Maybe it is time take the loss or profit on them because they are over valued, regardless of their past performance.
I think its really important to keep track of your portfolio. So many people neglect to manage it after they see there equity fall. I guess its too depressive to see how much money you have lost. However, you still can do something about it and by rebalancing your portfolio you can hopefully turn the losses into gains!!!
I really like this article. I have been listening to investtalk radio and this goes right in line to what Steve Peasley (host) thinks. You guys should check it out, just go to investtalk.com.
What an excellent article. I really hope you don’t mind that I am going to be printing it out so that I can refer to it later.
I guess I never thought about “harvesting your losers” this way.
Thanks.
I personally love these types of markets because even the great profit-enhancing companies get hammered which means that you can pick up some real bargains.
If you can sort out the wheat from the chaff then you can make a lot of money when the recovery comes.
The trick is not to make big purchases of these bargain shares in one go but drip-feed your money into these companies in case they drop lower in the meantime.
Nice set of tips. Of course the market could continue fooling the majority as it does most of the time. I hear most people complaining that the way to go now is by actively trading. I guess pigs would always get slaughtered..
Frugality has been the mantra for me this year. I really never realized how much money can be saved by keeping an eye on those nickels. I used some simple ways like making greater use of my Kroger card and selling off old Wii games on eBay saved so much money for me.
Stock gains and losses are capital in nature in Malaysia so we don’t have write off’s (except for those whose business is trading in stocks).
But the rest of your points make a lot of sense, especially #6 and #10.
Cheers
I think people need to become more educated about stocks and know when to stay out of the market.
If you’re long on anything and are really in it for the long haul, out-of-the-money covered calls are another strategy to consider. With the VIX hovering around 35, implied volatility is high which means you can likely get a good premium on any long positions you have.
you can still keep going with systematic investment plan. It may generate very less return for some time but whenever market looks up it will be in profit in no time
People should stay in cash till the bottom, then load up the boat!