What should I expect during a bear market?
Presented by Kris Maksimovich, AIF®, CRPC®, CPFA®, CRC®:
In the last downturn, we saw firsthand the reckless and self-serving behavior of some brokerage firms and banks. Of those that didn’t go out of business with their “creative” bets on the mortgage market, others harmed the global economy. We can only hope that lessons were learned from the 2008-09 market drop.
As with any bumpy market ride, do-it-yourselfers quickly realize that they aren’t quite the geniuses they had hoped. Even the bump from the Reddit wizardry was short-lived. Some advisory firms may begin providing “happy talk” in their investment commentaries, and some customers may be puzzled why their broker or advisor stopped contacting them as a downturn worsens.
As a matter of historical reference, markets have resided in bearish territory approximately 15% of the time since World War II. Investors who stayed the course during the 2008-09 downturn generally experienced a quadrupling of market value in the bull market that followed. While we can’t predict the scope of the downturn, opportunities and unexpected rewards do exist in the months ahead.
For us, it is during this type of crisis that our preparation, planning, and commitments are reflected in our client relationships and strategy. During a volatile market, we remain timely, frank, and pragmatic.
The opportunities
Stay the Course by Dollar Cost Averaging – Stay the course and continue to invest in your 401(k), employee stock purchase programs, and other “auto-investment” accounts at regular intervals. Take advantage of employer matching, the shares you buy on the way down will become profitable when the market comes back, and it will.
Tremendous Buying Opportunity – Understandably, this bear market is stomach-churning, but patience can be rewarded. Now is the time to put together a shopping list of all the stocks you would like to own. There will be some great deals if you have the necessary patience to ride out the bear market. But do not rush. With an earnings season upon us which is sure to disappoint we will most likely continue to see volatility in the months ahead.
Tax Loss Harvesting – Tax management is an option for enabling investors to mitigate the loss of value in a market sell-off in after-tax accounts. This strategy enables investors to extract a tax benefit out of market chaos. Here’s a simplified example of the benefit derived from tax-loss harvesting:
- Mrs. Client bought 100 shares of ABC, a technology stock, on Feb 1st at a closing price of $101.00. By the close of Feb 28th, the price had fallen to $87.00 – a loss of approximately 14%. Mrs. Client’s advisor harvested that loss at the close on Feb 28th and replaced ABC with XYZ, another technology stock. The result is:
- The client still has the investment in their portfolio if the technology sector rebounds
- They also realized a short-term capital loss of 14%, which at a short-term capital gain/loss tax rate of 40.8% realizes tax savings of $5.81 on the position
- On a 14% loss in market value, the client extracted 5.7% in tax savings, mitigating the overall loss in value to themselves to 8.3% versus a 14% loss
Imagine expanding this scenario across your entire portfolio and you can see how the tax savings could be substantial. What’s more, if this bear market ends up being a short-term pullback and the market progresses to new highs, she just pulled out tax savings of 5.7%, versus a buy/hold approach which requires riding out the volatile market. If the market continues to further dip, the position can be harvested yet again, continuing the process of mitigating the loss of value.
Don’t overlook the long-term benefits
With losses harvested and assets transitioned, the long-term benefits of this strategy can be realized. Revisiting the example above, imagine that XYZ’s technology position remains untouched and years later is sold for $200. The benefits continue:
There is power in compounding – If Mrs. Client allowed the 5.7% saved in taxes to earn for 10 years at a 4% return, it would grow to 8.4% of the original investment amount. Checking in at 15 years it would more than double the original 5.7% in savings.
Offsetting the capital gains rate – The 14% loss offset a short-term gain by deferment into a long-term gain because ultimately it was taxed at a lower long-term capital gains rate (currently a maximum of about 24% for long-term vs a maximum of about 41% for short-term).
Different tax brackets – When the technology position is sold later, Mrs. Client may be older and earning less, placing her in a lower tax bracket with a lower capital gains tax rate.
Avoiding capital gains – Should Mrs. Client hold the position many years before donating it to charity or leaving it to heirs, she would avoid the capital gains taxes altogether.
Not only did Mrs. Client defer short-term capital gains, but she compounded returns on those gains and lowered the potential taxes she might have paid. In some instances, she may even pay no taxes at all.
Understand your risk tolerance in a bear market
Our clients’ portfolios were created and have been managed with just this type of market decline in mind. Our risk-tolerance software has enabled us to hold a frank discussion with people about how much risk is in their portfolio and how much risk they can tolerate. As a service, we offer this software for free to those who would like to understand their “risk number”. We also offer a free comprehensive portfolio review for those who are concerned about the market and are unsure of what their next step should be.
With patience, the market downturn will pass, and the new strategies adopted will help your portfolio recover when the market begins to rise again.
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Kris Maksimovich is a financial advisor located at Global Wealth Advisors 4400 State Hwy 121, Ste. 200, Lewisville, TX 75056. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Financial planning services offered through Global Wealth Advisors are separate and unrelated to Commonwealth. He can be reached at (972) 930-1238 or at info@gwadvisors.net.
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