How Can You Take Advantage Of This Bear Market?

Well, it's official. The Fed poked the bear. Investors are now dealing with fears of inflation and an economic slowdown. Rising interest rates are putting the economy under even more pressure.

The recent sky-high consumer price numbers revealed higher inflation and caused the Fed to bump rates by .75% on June 15, 2022—the most significant rate increase since 1994. News sent stocks down further, pushing the market deeper into bear territory. 

But what's a bear market anyway? And how should you approach it with your investments?

What IS a bear market?

A bear market, by definition, is a decline in the market of at least 20% from recent highs as reflected in a broad index like the Standard & Poor's 500 or the Nasdaq Composite.

But it may be more beneficial to talk about what a bear market is NOT. A bear market is NOT a guarantee of a recession and is NOT a reason to move into cash. 

Bear markets are a fact of life for long-term stock investors. While it can be painful to see your portfolio dip—especially if you are nearing retirement and have a large nest egg you plan to rely on for income generation—a bear market should not derail your well-laid retirement plans. 

Remember, higher prices have eventually followed every bear market in history. But, that doesn't mean there aren't steps you can take in a bear market to manage your losses and improve your long-term investing returns at the same time. Here are some options to think about:

Rebalancing

Theoretically, rebalancing should be about buying low and selling high. Logistically, this is accomplished by buying and selling assets in a portfolio to change the weight of different investments within the mix of the total portfolio.

For example, let's say you used to hold a 60/40 portfolio, one with a 60% allocation to equities and a 40% allocation to bonds. For decades, this has been considered a safe portfolio allocation, especially for those with retirement in their sights. Bonds have historically been used to generate income and provide down-market protection. Recently, they haven't been able to do either. Make sure you understand the bonds you own and why you own them, if you're concerned interest rates will continue to rise.

Reinvest Dividends

One way to bolster your portfolio when values are down is to reinvest any dividends you may earn rather than taking them as a payout. This means you use your earned dividends to buy more shares of the company fund rather than receiving the payments as a check. Doing so is a form of compounding that helps you buy more shares of the stock and, in turn, earn more dividends from those stocks in the future.

Roth Conversions

Roth conversions can offer a silver lining to the stock market plunge. If you have a traditional IRA, converting your funds to a Roth while low values can offer significant tax savings.

As you likely know, traditional IRAs are tax-deferred investment vehicles funded with pre-tax dollars, which means you pay income on the withdrawals after retirement. A Roth IRA, however, is funded with after-tax dollars, which means you pay taxes on the contributions to receive tax-free withdrawals in retirement.

But, you can convert a traditional IRA to a Roth by paying taxes on the funds rolled over upon conversion. Because the value of your investments within the account is down, you would pay less taxes on the rollover now than you would when the prices are high. Overall, you pay less to roll over the funds and can enjoy the tax-free benefits in retirement.

Double Down and Go Shopping… for Investments!

Everyone loves a good sale, right? But this time, it's not on new bedsheets but your favorite companies. Buying at depressed prices sets you up to benefit even more from the eventual rebound that will occur when the bear market ends. The more shares you can acquire of your favorite investments now, the more you'll earn from them in the future. 

Tax Loss Harvesting

Tax-loss harvesting is the process of purposely selling a depressed stock or mutual fund to offset gains in another area of your portfolio or to offset increases in your ordinary income. Just be sure that the investments you are selling off aren't an integral part of your portfolio during the "winning season." You'll want to pick stocks to offload that haven't historically provided the returns or ballast you've needed in the past.

Fight the Urge to "Do Something" If It Isn't Necessary

Sticking with a sound investment strategy when stock prices are falling takes discipline. But, investors who make impulsive moves like moving to cash or selling some of their stocks miss out on the potential for their portfolio to recover and eventually profit again.

The above strategies can help you make smart money when the chips are down. But even though the urge to do something or take action in a bear market can be overpowering, make sure you're not just "doing something for the sake of doing it" and that the moves you're making benefit your long-term plan in a meaningful way.