When the market drops our natural tendency is to preserve capital and move out of stocks and into cash or some other relatively safe investments. The so-called “flight to safety” is alive and well as we enter the second half of January.
But is that really the best way to manage a volatile market?
Below are nine things to do when the market tumbles.
1. Do nothing. Yes, nothing can actually be something. And sometimes doing nothing is the exact right thing to do when you feel that something must be done.
This Yogi-Berra-like strategy makes sense when your goals are long term and your investments are properly aligned with your goals, time horizon and risk tolerance.
Remember that time in 2011 when the markets dropped over 19%? I didn’t think so. According to a guide titled “Market Insights. Guide To The Markets” published by JP Morgan, as of December 31st there have been 5 major pullbacks in the S&P 500 in the current market cycle. The most severe was in October of 2011 when the market sold off over 19% before going on to reach new highs.
In fact, since 1980 markets have experienced “intrayear” declines of about 14% on average. 75% of the time, the market posted gains for that same year.
Most of the time doing nothing was the right something to do.
2. Buy more. Depending on your risk tolerance and time horizon, the time to add money to your stock portfolio is when markets are down. Sure, they could go down more and tomorrow could present an even better opportunity to buy, but the only thing we know for sure is what we have today.
More than likely your favorite stock or mutual fund is cheaper to buy than it was a month ago. If you buy today and the price simply goes back to where it was a month ago, you stand to make a nice gain.
An easy way to do this is to increase your 401(k) contribution. It’s tempting to reduce your contributions when you see them lose value every day, but the silver lining is that by contributing regularly to your IRA or retirement plan you are able to buy more shares at lower prices. In the long run, you will be better off.
3. Fund your IRA for the year. Similar to the advice above. If it makes sense to buy stocks and other investments when the markets are down, it makes sense to fund your IRA, Roth IRA, SEP-IRA, etc. when markets are low as well. The IRS allows taxpayers with earned income to contribute up to $5,500 per year (plus $1,000 if you are over age 50).
What’s more, you can fund last year’s IRA right up April 15th. If you wanted to make the most of this sour market, you could fund your 2015 AND 2016 IRAs today, while prices are low. If you are married, this means you could contribute up to $22,000 into your IRAs – even more if you are over 50.
4. Build up your cash reserves. Adding more to the market when markets are down can be a sound long-term strategy for people who can tolerate the volatility of stocks. But if your cash reserves are low, consider increasing them to a more comfortable level before adding more to the stock market.
For people who are still working, that may mean having money market funds, bank savings, or other cash on hand to pay for short-term expenses or to provide a cushion if your income were to decline.
Long-term investments like stocks and stock mutual funds work best if you can leave them untouched for long periods of time. Dipping in to your stock portfolio to pay for college tuition, your kid’s wedding or the mortgage payment while markets are down can sink your portfolio value as fast as any bear market.
5. Pay down debt. Rationally you understand that you should buy more while markets are down, but emotionally you just can’t do it. I get it. In this case, maybe you should focus on other priorities like paying down your credit card, student loan or even your mortgage.
Any extra amount you can pay down towards your debt helps. In fact, depending on your interest rate, paying down debt is like getting a guaranteed 4%, 6%, 10% or more on your money. Hard to beat that.
6. Convert IRAs to Roth IRAs. Roth IRA conversions are taxable events. Obviously the less you convert, the less tax you pay. An IRA worth $10,000 last month may be worth $9,000 this month. Converting today reduces your tax bill by 10% due to the lower value of your account.
7. Dump your dogs. Markets are down across the board. Selling for the sake of selling probably isn’t a good idea. However, if you have investments that were questionable to begin with, now may be a good time to dump them and replace them with something else.
The idea is to be positioned for the next market rally. If you don’t believe your investments will recover strongly when the market bounces back, consider other investments. Sometimes a down market can be just the push you need to make that change.
8. Consider an annuity with a guaranteed income benefit. Annuities aren’t for everyone, but if an annuity with a guaranteed income benefit makes sense for you, then now may be a good time to consider one.
Here is why: The income benefit often ratchets up based upon a fixed, guaranteed amount or an increase in the market value of your account, whichever is greater. If you add to an annuity with such a benefit when markets are down, you stand a greater chance of seeing that income benefit increase by more than the guaranteed amount when markets rebound.
Annuities are complicated investments that aren’t suitable for everyone and every annuity product is different. Do your homework and read the fine print carefully.
9. Complete your college financial aid forms NOW. The FAFSA form asks for the value of your assets as of the day you fill out that form. Today your assets may be worth a lot less than they were at the end of the year.
By filling out your college financial aid forms now, you will decrease your Expected Family Contribution (EFC) and possibly increase the likelihood of having financial need. The greater your need, the more likely you are to get some financial help when paying for college.
Market volatility happens. What you do when it happens makes a difference. I plan to implement the first three ideas.
What’s your plan?