Responsible Investing During Market Downturns

Jeff Witz

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It has been a bumpy road for investors so far in 2022. As of this writing (5/27/2022), both domestic and international equity markets are down, with the Dow Jones Industrial Average down 9.68% year-to-date, the S&P 500 down 13.79%, and the MSCI EAFE down 12.35%. To make things more challenging for investors, bonds have also been down. Bonds are a common safe haven when equity markets are down. The Bloomberg US Aggregate bond index is down 8.52%. In the current market environment, there are very few places to hide.

When the markets are down a considerable amount, it’s common for investors to feel a sense of panic, like they are losing all their savings. Bombarded with “the sky is falling” financial news, many investors are tempted to sell to hold onto what’s left. However, these moves typically provide short-term comfort at the expense of long-term goals.

A key to long-term investing is riding out some of the valleys the markets may experience. If you pull yourself out of the market, you may miss out on the recovery and the ability to make back some or all your losses. For example, after the 2008/09 financial crisis, in which the S&P 500 was down as much as 51%, the following rally lasted 118 months and was up over 300%.^[1] Following the Dot-Com crash in 2000, when stocks were down 45%, the following rally lasted 61 months and was up over 100%.^[2] In fact, following every sustained down market has been a significant and sustained upward rally.^[3]

To take advantage of these rallies, you must be invested in the market. Sitting on the sidelines and missing the rally, even for a short amount of time, can have a significant impact on the assets you have later in life. Now, if you are thinking “I’ll just sell when things start going down and then buy back in at the bottom,” be aware that correctly timing the market is very difficult to do. How will you know when the market is headed for a sustained downward trajectory, and how will you know when the market has reached bottom? Predicting when these things will occur is nearly impossible and guessing wrong can significantly impact your investments negatively.

Patience and discipline. That is what it takes to survive a market downturn. Patience is knowing the markets will eventually turn around and move in a positive direction. Discipline is sticking to your asset allocation strategy and diversified investment mix that were put in place to help you achieve your investment goals.

However, if you feel that you must take some sort of action, there are a few activities that can be helpful:

Dollar cost averaging. If you want to invest, consider dollar cost averaging. When markets are down, many investors actually consider it a buying opportunity. However, knowing when the market has hit its bottom is nearly an impossible task. Dollar cost averaging removes some guess work. It is an incremental investment strategy that can be used to buy into investments at various prices. Some investors dollar cost average by selecting a specific drop in the market, for example, every 500 points the DJIA drops they will invest another amount. Others dollar cost average based on timing by selecting a day each week or each month that they are going to invest. If guessing the bottom is impossible, the next best alternative is investing incrementally at hopefully advantageous prices.
Rebalance your portfolio. Any time the markets are moving quickly upward or downward, certain assets tend to outperform and underperform others. This can cause the portfolio to move away from the target asset class allocations. Rebalance your portfolio by selling positions that have become overweighted and move the proceeds to positions that are underweighted.
Tax loss harvesting. In taxable accounts, when markets turn negative, there may be an opportunity to sell investments at a loss and use the captured loss to cancel out gains or up to $3,000 of income. Tax loss harvesting can help these accounts become more tax efficient moving forward.
Review your risk tolerance. Risk you took on years ago may no longer make sense given your current circumstances and life stage. If you are less open to risk, consider adjusting your target asset allocation.
Implement defensive strategies. There are defensive steps you can take to protect your positions. Stop orders and stop-limit orders can help shield unrealized gains or limit potential losses on an existing position.

When the markets are down significantly, you may become tempted to act. However, you may cause more harm than good by reacting during these time periods. It is very difficult to correctly guess when to get out of the market or back into the market. If you must act, consider less severe actions like dollar cost averaging, rebalancing, tax loss harvesting, and applying defensive tactics.

Before taking any action, however, we recommend you speak with your financial professional or CPA to better understand the financial or tax implications.

Jeff Witz, CFP® welcome readers’ questions. He can be reached at 800-883-8555 or witz@mediqus.com.

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