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).
While it’s only one of several factors when evaluating how to choose a financial advisor, understanding how we’re compensated is crucial for aligning incentives with yours.
Here are five reasons to work with a flat fee, advice-centric financial advisor:
There’s very little conflict to try and “gather your assets”.
Why is this important? If you’re working with an advisor who charges based on the amount of assets under management, there will always be an inherent incentive to try and “gather” your assets since the more money that’s managed, the higher the fee the advisor can receive. This can cause conflicts of interest in certain situations. For example, leaving money in an employer-sponsored retirement plan can be advantageous to keep pre-tax money out of a Traditional IRA and minimize taxes for backdoor Roth contributions. The assets under management (aum) fee model is not close to being the worse compensation model (for fee-only financial advisors) and many great advisors use this model.
However, you cannot deny the conflicts it creates.
There’s no more work involved managing a $100,000 portfolio versus a $10,000,000 portfolio.
Technology has leveled the playing field when it comes to managing investments. There’s still tremendous value in getting people invested appropriately for their needs, goals, time horizon, etc.. However, when it comes to the logistics of managing investments, it’s literally the click of a button. Even less if the advisor uses a third-party manager. There is an argument to be made that higher dollar decisions justify higher fees, but paying (potentially) 100x for a similar service doesn’t make sense to me.
Financial Planning is the main focus.
Regardless of the compensation model, advisors that are advice-centric, planning focused are the most beneficial. Why? As mentioned, since technology has provided us with so many great, low-cost investment options, the most value an advisor can provide you is by taking advantage of the resources available to you. This means putting you in a position to succeed based on your short and long term goals. Planning for tax diversification, understanding how much of your income you need to save to achieve your goals, and how to transfer (or mitigate) risk are a few essential parts of financial planning that have very little to do with investment selection. An advisor that charges solely for advice will always be accountable to provide continuous value.
Percentage fees can have a massive impact on long term growth.
If we’re being conservative and making realistic long term assumptions about investment returns — even a percentage (1%) can have a large impact on the end value of an investment portfolio.
For example, if we assume long term returns of a “diversified investment” portfolio to be 7% and inflation to be 2.5%, that leaves you with a “real” 4.5% growth. Even at a 1% asset management fee, that’s (potentially) eating away at 20-25% of your real return.
Food for thought.
You always know exactly how much you’re paying and what you receive in return.
It’s just like paying for any other professional who provides a service. You make a conscious decision about how much you’re willing to pay and what you receive in return.
There are no guarantees. There is always uncertainty.
Even when you have an unbelievable vision.
I love this clip of Jeff Bezos (scroll down). It shows his foresight about the future of retail and customer service. What stood out to me was his humility to recognize the uncertainty of who the expected winners of the ‘internet revolution’ would be.
“Long term I believe that it is very easy to predict that there are going to be lots of successful companies born of the internet. I also believe that today, where we sit, it’s very hard to predict who those companies are going to be.”
In hindsight, it’s easy to look back at Jeff Bezos and his vision to ‘know’ that Amazon would be a massive success. Even Jeff Bezos recognized the uncertainty he faced along the way.
For long term investors, it’s not about predicting the exact winners, it’s about making sure you have exposure to those winners.
As long as you’re saving enough on an ongoing basis, a long term investor can afford to own companies that will not be winners to the magnitude of Amazon.
What the long term investor cannot afford, is completely missing ‘the next Amazon’ altogether. The best way to do that is through diversification.
Jeff Bezos in 1999 explaining (ironically) the importance of diversification.
There are no guarantees. There’s always uncertainty. Even when you have a great idea and vision.
For the majority of us, the wealth building process does not happen overnight! Here are five starting points for the modern wealth builder:
1. Understand where your money goes
What are your fixed monthly expenses? How much wiggle room do you have for discretionary spending? In order to grow your net worth, you must first understand how much money you can afford to put towards your savings and investments on a consistent basis. Even if you’re not sticking to your budget on a monthly basis, being able to review what you actually spent is important for projecting out savings goals.
2. Have a dedicated cash cushion
Responsible wealth builders have a dedicated cash reserve at all times. This is so they are not dependent on their investments to pay for life’s unexpected expenses. Having a cash cushion also allows the modern wealth builder to invest with confidence and stay disciplined to their investment strategy.
3. Take advantage of employer benefits
Modern wealth builders take advantage of employer benefits and don’t leave free money on the table. This includes taking advantage of an employer match through a workplace retirement plan and making the most of other pre-tax benefits.
4. Have a hierarchy for investing accounts
Modern wealth builders have a hierarchy for investing in the different types of tax-deferred retirement accounts. Making sure to utilize tax advantageous accounts first will help improve a wealth builder’s bottom line net worth.
5. Invest based on goals and controllable factors
Modern wealth builders are concerned with investing based on the goals they are trying to accomplish. They focus on the factors that are within their control and tune out the noise of financial media.
It’s not uncommon for a young professional’s first interaction with a financial advisor to be through their parent’s advisor. However, just because that advisor was a good fit for your parents, does not necessarily mean they are a good fit for you.
So, when should you break up with your parent’s financial advisor?
You’re not receiving personalized advice
The relationship is investment centric
You feel like an afterthought
They don’t understand the challenges you face
They’re not easily accessible
Since most advisors are compensated based on the size of a person’s investment assets, a young professional who is early in a career most likely won’t have the assets to incentivize that advisor to spend the time needed to help them make smart decisions with their money. The reality, however, is that an advisor can add a tremendous amount of value to the future financial health of a young professional before they’ve accumulated an investment portfolio large enough to be “profitable” for a traditional financial advisor.
Luckily, hundreds of advisors specialize in working with young professionals. A great place to start your search is the XY Planning Network. The XY Planning Network is a network of independent advisors who are required to put your interests before their own and strictly operate on a fee-only basis, meaning they never sell products with commissions.
Also, many advisors in the network (including myself) utilize a subscription fee for their services — meaning regardless of your age or asset size, you can work with someone who is going to provide you the attention you deserve.