Bear Markets: The Challenges and The Opportunities
By Zachary Bainter, CFP
After more than 10 years of record expansion, the US economy likely entered a recession at the end of March. The war against COVID-19 has put a halt to our economy. For those of you invested in the stock market, you likely noticed the economy was going to have a challenging time ahead, judging by the sudden and sharp decline in stock prices towards the end of February. When the stock market goes down more than 20%, it is colloquially referred to as a bear market. Bear markets present a set of challenges for investors -and also opportunities for those who are patient and disciplined.
Despite the speed at which this particular bear market happened, there is a playbook on how to survive. Similar to how you are supposed to respond if you see a bear in the wild -do not panic. Hopefully, you are in a position where you appropriately planned. This entails having ample cash reserves in the bank and/or short-term investments that are easily accessible and not prone to the same fluctuations as the stock market. If you have cash reserves -and know you don't need to access your investments during these times -it's easier not to panic and stay the course. If you did not plan as well this time, there are still things you can do to survive and then thrive when the market and economy recover.
One of the best moves you can make during a bear market is to harvest tax losses in taxable accounts. This involves selling stocks, funds, or other investments whose price has fallen below what you paid. It's easy to be emotional about holding an investment that is at a loss but think about the loss as an asset. You can use this loss to offset a current year capital gain, offset up to $3,000 in ordinary income this year, and carry forward any additional losses indefinitely. Savvy investors can put the sale proceeds into a similar, but not identical, investment. This allows for your plan to mostly stay intact while simultaneously receiving some tax relief.
Another strategy to employ is to rebalance your portfolio. Rebalancing is a process that involves recalibrating your portfolio back to the prior allocation from mid-February before the stock market began its swoon. For example -let's say your prior allocation was 50% in the ABC stock fund and 50% in the XYZ bond fund. Now the allocation is 40% ABC stock fund and 60% XYZ bond fund. By rebalancing, you effectively sell 10% of your portfolio's XYZ fund and buy the ABC fund with the proceeds-effectively selling high and buying low. Depending on your risk tolerance and time frame, you might do this in one move or over a series of transactions. It's important to keep in mind that rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
A third strategy to employ is conversions. If you have a retirement account that will eventually be taxable, such as an old pre-tax 401(k) or Traditional IRA, you can convert these accounts to a Roth IRA. The converted amount is taxable in the year of conversion. If the account value is much lower due to the stock market, then the converted amount and eventual taxes are less too. Please consult a tax advisor or financial planner before doing this or any of the strategies discussed.
One final thought. Though this recession has just begun, it's important to know what signs to watch for to determine if the recession could be ending. As dark as some of the headlines have been and will continue to be, it is imperative to remember that the stock market is forward-looking. In recessions since WWII, stocks bottomed about five months on average before the end of the recession, as stocks were able to look past the current negatives and sense better times ahead.
Securities offered through LPL Financial, Member FINRA (http://finra.org/)SIPC(https://www.sipc.org/). Investment advice offered through Gerber Kawasaki Inc, a registered investment advisor. Geber Kawasaki and Gerber Kawasaki Financial Advisors are separate entities from LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss. Gerber Kawasaki, 2176 Ocean Park Blvd. #2022 Santa Monica, CA 90405. Contact us (310) 441-9393