Stocks go up, usually for long stretches of time. Sometimes they fall.
Typically, investors can simply wait out the downturns, but not always. Life intervenes: A surprise medical bill, a college tuition payment or some other need requires cash, immediately.
Selling in a declining market is no fun but there are ways to soften the blow. Obviously, having a larger cash position in a money market fund is a great way to avoid having to liquidate an investment you would prefer to keep.
Short of that, consider the following strategies to offset the impact of untimely selling.
Strategically rebalance. Think long term when it comes to your gains. Imagine that you target a 60 percent stocks and 40 percent bonds portfolio. A steadily rising stock market might mean you are now overweight stocks, perhaps closer to 70%.
Conversely, your bond portfolio may have appreciated more than you might realize as scared traders rush into safer investments. It might not be dramatically higher, but remember, as yields fall, bond prices go up.
Chances are, the pain of selling won’t be so terrible if you consider it as overdue profit-taking in order to rebalance. Once you sell enough to rebalance, put some in near-cash investments, such as a short-term bond fund, to build your cash cushion for next time.
You probably get told to rebalance around tax time to generate cash or in order to take required minimum distributions. It can feel a bit automatic, like brushing your teeth, but rebalancing is an important way to reduce your risk before a downturn.
Making rebalancing a twice yearly or quarterly exercise can help you move toward a higher cash holding, say 5%, which can help you avoid panic sales in a down market.
Reorganize your holdings. Experienced investment advisors sometimes describe incoming client statements as “yard sale” portfolios. They open up a statement to find piles of stocks and bonds willy-nilly with hardly any strategic thought behind owning them.
A decline in the stock market can be a severe test of will, but that test becomes somewhat easier once you look at your holdings line-by-line. A stock that caught your fancy 20 years ago might no longer belong.
If the position made you money but no longer fits, sell it and replace it with something more pertinent to your goals. If a stock mutual fund you bought because of a star manager is now being run by people you don’t know, maybe it’s time to reassess.
On the bond side, consider whether the bonds or bond funds you hold are the right fit for your needs. The relative duration of the bonds you hold say a lot about your expectations for interest rates in the near future. Do those expectations hold? Would other bond investments make more sense?
If you are forced to sell investments today to generate cash, why not use that energy to make better choices for the future of your portfolio? Chances are, you still need to invest for 10 or 20 years down the road. Never waste a crisis, as they say.
Pay less taxes. If you invest in taxable accounts, remember that losses can help you pay for the taxes on your gains. If you need cash anyway and have to sell at a loss, make up for some of that pain by offsetting taxes in the future.
That applies to investment gains but also up to $3,000 in ordinary income taxes. There are rules around tax-loss harvesting, the most important being “wash sale” restrictions against selling and repurchasing a position within 30 days. Talk to your tax adviser before taking action.
If you are selling at a gain, great. Never cry about being taxed on money you made investing. However, do remember that your tax rate will depend on how long you own a specific investment.
If you hold a stock for a year and then sell the capital gains rate is 20%. If you sell in less than a year your tax rate is determined by your federal income tax rate. That might be more than 20%.
Have a plan. When markets rise inexorably, year after year, it can be easy to ignore the gains and just accept a bull market as a reality of life. That’s a mistake.
A more strategic way to invest is to consider what your investments will be paying for and when. If you are near retirement, for instance, your mix of stocks and bonds will be far different from someone in, say, their early 40s.
Holding more cash in a rising market can feel useless, but there is wisdom in being able to cover expenses no matter what is happening in the world. That might mean targeting a short-term reserve in your portfolio. Holding cash or cash equivalents will insulate your decision-making process from the pressure of daily market volatility.
If you haven’t revisited your holdings in a while and aren’t sure, now is a good time to sit down with an adviser and talk about your plans, both short term and over the long run.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.