Even if you’re not dependent on your investment portfolio, losing money (even if only temporary) is never fun. Fortunately, there are strategies you can take advantage of to lessen the impact of a bear market and *hopefully* set yourself up for success when markets rebound.
Although no one knows when markets will rebound, now is the time to fight panic and be proactive with planning.
Here are three strategies you can take advantage of during a bear market:
When investments in a taxable account drop in value, “harvesting the losses” is a great strategy for lessening the impact of these losses.
Any losses harvested can be used to offset gains that have been realized (in that tax year), effectively reducing taxes owed. If you have no capital gains to offset, you can use up to $3,000 of loss to reduce your taxable income, or $1,500 each if married filing separately. However, the additional tax loss may be carried forward for use on future tax returns.
One of the key things to be aware of with tax-loss harvesting is to make sure you avoid the “wash-sale rule”. The IRS won’t let you buy an asset and sell it solely for the purpose of paying less taxes. The loss will be disallowed if the same or a substantially identical asset is purchased within 30 days.
It’s important that you get back invested right away after taking advantage of tax-loss harvesting (so that you don’t miss out on potential rallies).
You want to make sure you avoid the wash-sale rule when buying a stock, mutual fund, ETF, etc. to replace the security you’ve sold to take advantage of the loss.
Luckily, there are plenty of options that are considered “substantially different” but still allow you to maintain your risk profile.
This only works if you have a defined investment strategy ahead of time. If you’ve done a financial planning analysis and determined how much risk you can afford (and/or is needed) in your portfolio to achieve your financial goals, now is the time to remain disciplined to that risk profile.
Even for the investor with a long time horizon (20 + years), it’s unlikely you would have 100% of your investment portfolio in stocks. If you had built in some kind of diversification into your portfolio, by owning other assets such as bonds, treasuries, and commodities, there should be room to rebalance back to your original risk profile.
The best way to rebalance is to have rules built in ahead of time. By having rules in place for when a rebalancing event is triggered, it removes the emotion from the decision making progress when you’re trying to determine “the right time to buy stocks”.
The time when it feels the most painful to rebalance back into owning more stocks is *usually” the best time to do so. While there is always the risk of increases in short-term decline, your future self should be rewarded for remaining disciplined to the risk profile that is appropriate based on your current financial situation.
It’s important to avoid “all-in” or “all-out” strategies. We don’t know the sequence of returns and we definitely don’t know when markets will bottom and rebound. The most important thing is to remain disciplined to your pre-determined risk profile to benefit once markets inevitably rally.
Planning for tax diversification is essential to any financial plan. Regardless of market environments, you should want to plan for flexibility in retirement to be able to pull from pre-tax and after-tax accounts depending on where tax brackets are at that time. That way, you’re not *totally* beholden to the unknown fiscal policy that awaits us.
If you’ve been looking to take advantage of Roth conversions to shift pre-tax money to after-tax accounts, now would a great time to consider converting securities that have declined in value.
By doing so, you’re putting yourself in a position to potentially benefit from substantial growth once markets rally. As a reminder, any money (or securities) converted to a Roth IRA will never be taxed again (after the conversion amount has been paid).
In this podcast episode, I discuss the framework for deciding how aggressive to be with employer equity compensation.
Equity compensation discussed includes Options (at-the-money vs out-of-the-money) vs Restricted Stock Units (RSUs).
In situations where there is a vesting schedule (over a 3,4,5 year period), it almost always makes sense to take the equity compensation (vs cash).
However, I also discuss situations where taking cash would make sense based on personal financial circumstances.
Equity compensation is an amazing opportunity to concentrate and grow your wealth. You just want to make sure you have a plan in place to minimize the tax ramifications and diversify in the long term once you’ve built your foundation for financial independence.
Dave is a big advocate for prioritizing paying off debt and ultimately living a debt-free life. Which, I would agree is a worthwhile goal.
BUT, just like anything in life, debt is a tool that, if used responsibly, can be beneficial.
If I have a mortgage, should I not step inside a restaurant until I’ve paid it off? I think it’s fair to give Dave the benefit of the doubt and say he’s referring to high-interest rate debt (like credit cards).
What if I graduated with student loan debt? Am I not allowed to ever go out to dinner and enjoy myself?
What if I work hard, live below my means, and are making progress towards my financial goals? Should I still not be allowed to treat myself to an occasional night out because I have student loan debt?
This is one of the differences between being a “personal finance guru” and being a financial planning professional that provides one on one advice. Personal finance is PERSONAL. Rarely are there situations where there isn’t nuance or it doesn’t “depend”.
Unfortunately, “it depends” doesn’t drive engagement like, “If you’re working on paying off debt, the only time you should see the inside of a restaurant is if you’re working there”.
If you want to live an all-or-nothing lifestyle, I respect it. I just don’t think it’s sustainable for the vast majority of us. I’d rather focus on creating a plan, and recognizing that you’re going to make “mistakes” (enjoy) yourself along the way.
The most important thing is that you are continuously making progress towards your goals even if you treat yourself to the occasional night out.
As a financial planner, I’m always talking about long-term investing, long-term financial goals, and blocking out the short-term noise of financial markets. The reality is, it’s extremely improbable we know what we’ll want 10, 20, or 30 years from now.
I’ve noticed that it can sometimes be difficult for people to articulate their long-term goals. Especially for younger people who are mostly focused on advancing in their careers and trying to figure out what the next step in their personal AND financial life should be.
When someone comes to me and is unsure of what they want in the long-term, that’s perfectly FINE. Part of the planning process is designed to help you figure out how you want to use your money to create the life you want.
There’s no question that personal finance is PERSONAL. However, when someone comes to me with a blank slate there is a hierarchy for how I want to see them use their money.
My goal is to help put them in a position to have the ability to do the things they want to do in life, even if they’re unsure EXACTLY what that is right now.
From a technical standpoint, that means showing them how to invest in a strategic way that will provide the potential to achieve financial independence in the future.
By establishing good investing habits early, they’ll be equipped to withstand the inevitable uncertainty that comes with investing in financial markets. This only becomes more difficult as the dollar amounts rise, and especially once you’re dependent on that money.
More important than investing decisions is showing them how to use their money in the short-term (each tax year) to fill up their tax-deferred accounts to set them up for future flexibility.
If they’ve completed the steps I advise them on, particularly how to maximize their money in the short-term — I’m confident they’ll have the flexibility to do the things they want, whatever that ends up being.