In today’s blog post and video, we’re looking at 3 investment strategies to “help you keep your cool in a bear market.” It’s not a matter of if we head in to a recession, but when… and we need to plan for it!
Ashley takes a closer look at the following strategies to help you prepare:
- The Bucket Strategy,
- The 5% Rule,
- And Tax Loss Harvesting.
It’s important to keep in mind that long-term plans shouldn’t be abandoned, in times of adversity. We try to position our clients to grow in good markets and protect in bad markets.
Click here to watch the full video or read the full video transcript, below.
If you want to make money long term by being a stock market investor, it’s absolutely critical that you’re able to keep your cool in months like October of 2018 or if and when we hit the next bear market. Now, I focus on the next bear market. A bear market is a drop of 20% or more in the stock market, very painful. It tends to coincide with a recession, and they tend to last about a year and a half. That’s month after month for a year and a half, where it doesn’t seem like it’s getting any better. The news continues to get worse, and at some point in the future, it’s going to turn around.
Now, the problem is, if you go back to 2008/2009 when we had the financial crisis, the market bottomed in March of 2009. At that time, unemployment was still getting worse. Every day, you’re hearing headlines about how the world’s financial system is still on its knees, and the world still seems to be coming to an end.
Yes, low and behold, in March of 2009 when nobody expected it to, the market bottomed and started a long, long upward march. It’s been tremendous over the last 10 years or so.
Keep Your Cool In A Bear Market
Debt fueled The Great Recession of 2008/2009. Chances are, the next time we go into a recession, it’s going to be more of what we would call a “garden-variety” recession. It’s not as deep and it’s not as long because it’s not driven by the same factors that really drove the market down in the last downturn.
The other thing I want to encourage you with is, if you look at your portfolio today, let’s say you are 58 years old today, you want to retire, transition out of full-time work in the next few years. If you go back 10 years, you were 48 – 10 years ago. Hopefully, your portfolio when it dropped in the 2008/2009 financial crisis, it looked a lot different than it looks today. When you were 48, you were much further from retirement. Hopefully you are also more conservative today and less prone to a deep or prolonged downturn in the market.
Those are a couple of areas I just want you to think about as we potentially head into another bear market and another recession. It’s not a matter of if, it’s a matter of when. We have to plan for it and prepare for it, if we expect to keep our cool.
Tip #1: The Bucket Strategy
This strategy is called The Bucket Strategy, and here’s how it works. You put away 18 months’ worth of living expenses. You have to know what you’re spending every month. Let’s say you know exactly what you’re spending every month. Whatever amount that is that you would normally draw out of your investment portfolio for that 18 months, you set that aside into a cash or cash-like bucket. It doesn’t have to be in cash. In fact, money markets right now, which are a cash-like investment, they pay about 2%. You could buy CDs, which are FDIC-insured. The rest of your portfolio can remain invested. It doesn’t matter so much if it goes up and down, because you are not relying on it for that particular time period to provide for your monthly living expenses.
Why do I use 18 months? Well, actually, this is a really important point, and it’s not arbitrary at all. If you go back over the last several decades, there have been quite a few bear markets, a jump of 20% or more, and quite a few recessions to go alongside that. The average bear market lasts for 17 months. Even if you go back to 2008/2009, that bear market lasted about 18 months. Even in a really ugly time period, chances are, if you have this set aside in cash, you’re not going to need to draw from your portfolio. You are much more likely to keep your cool if you know that you have cash set aside to cover your living cost and shore things up during that difficult time period.
Tip #2: The 5% Rule
Now I’m going to talk about strategy number two, which is what I call The 5% Rule. This is something that we have used with our clients for many, many years. We used it with our clients before I ever came around. It works really, really well in good markets and bad markets.
If you follow the strategy of The 5% Rule, it takes out the emotional temptation. It actually forces you to buy low and sell high. If your asset allocation or your mix of stocks and bonds gets out of balance by 5% or more from where you should be ideally, we get you back up to where you should be. If you go from 60% stocks to 55% in stocks, then we would take money from the bond side of the equation, move it back into stocks.
Tip #3: Tax Loss Harvesting
Strategy number three. The third and final strategy to keep your cool in a downmarket, this one’s a little bit more complex. I’m going to ask you to just stick with me through this. I’m going to try to explain it the best way I can. This strategy’s called Tax Loss Harvesting.
You would never do this in an IRA because it doesn’t make sense. However, if you own a position like this in a taxable account – it’s under water, it’s worth less today than what you paid for it – you can sell it. You would sell it for $8,000. Now, because you paid $10,000, you have a loss on that investment of $2,000. You get to report that loss on your taxes, and it helps you offset gains. It basically helps with your tax situation. You get to benefit from that today by realizing that loss or harvesting the loss.
Now, you don’t have to stay out of ABC stock forever. Let’s say ABC stock is a really great investment long-term, you still believe in it. However, you really wanted to take advantage of that loss, and that’s fine. All you have to do is stay out of that investment for about a month. Then you can buy back the stock a month later after you sell it and continue to own it just like you did before. Instead of paying $10,000, let’s say you buy it for $8,000 when you buy it back. Hopefully, it does better for you in the future than it did during the time frame that you owned it.
The market has been so good over the last several years…
Therefore, many investors haven’t been able to use Tax Loss Harvesting as a strategy. It’s a strategy that works really well in down markets. It can help lower your taxes this year. It also helps you sell investments that you maybe paid too much for when markets were good. You can buy those investment’s back at a lower value if they’ve gone down in value today.
Those are the three tips: The Bucket Strategy, The 5% Rule, and Tax Loss Harvesting. These are all ways that you can keep your cool in a bear market