Opportunities in a fearful environment
The stock market is one of the most effective ways to accumulate wealth. It can also act like a roller coaster. Asking it not to act like a roller coaster is like asking the sky not to be gray during a thunderstorm. Therefore, we must understand the market's dynamics and plan for periods of volatility. If you have followed Harford Financial Group or worked with any of our advisors, you know that we do this as part of your plan – we categorize our money into three categories: now, soon, and later. The stock part of your portfolio primarily lives in the later bucket. This time-segmented approach allows stocks to fluctuate occasionally, but ultimately rise over the long term. The Soon bucket provides us with breathing room from this volatility, utilizing money we plan to use over the next two to ten years. Since we have reduced or eliminated the pressure of having to make distributions from stocks when they are down, one can now view volatility as an opportunity.
In his 1986 letter to Berkshire Hathaway shareholders, Warren Buffett wrote, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
So, how does one attempt to be greedy when others are fearful?
Continue Investing
For those in the accumulation stage, continue saving for your goals, be it retirement or education funding. Adding more money to more stock-oriented investments during times of market volatility is a wise strategy. Here, you can purchase more shares with fewer dollars, allowing your investment to go further. Many may have heard of Dollar-Cost Averaging, where a fixed amount of money is invested regularly, regardless of market conditions. Dollar-cost averaging can help reduce the overall cost of an investment and mitigate the impact of large price fluctuations, resulting in a more favorable average purchase price over time.
For those in the distribution stage, although there may be fewer opportunities to continue investing with the dollars earned, there are still opportunities for your money to work for you by reinvesting dividends and interest into your portfolio. During periods of volatility, reinvesting dividends and interest allows you to accumulate more shares at discounted prices, helping to grow your income base and enabling your portfolio to recover more efficiently and expand.
Rebalancing
Periodically adjusting your portfolio back to its original alignment or stock-to-bond allocation can be a wise choice during periods of market volatility. Rebalancing helps reduce risk by ensuring you have a diversified portfolio even as individual asset classes fluctuate in value. Rebalancing during periods of volatility allows you to buy more assets that have fallen in price, potentially increasing long-term returns. Rebalancing also helps correct any drifts in the portfolio by selling what has performed better and buying what is undervalued, bringing the portfolio back in line. This process adds structure during uncertainty, keeps your portfolio positioned for recovery and growth, and maintains alignment with your plan. Here at Harford Financial Group, we consider portfolio rebalancing at each of our quarterly investment committee meetings as part of our fiduciary responsibility.
Cost Basis Management
Periods of stock market decline also present an opportunity to reposition your portfolio from a tax standpoint through tax loss harvesting. Tax loss harvesting is a method for managing the cost basis, or the value from which capital gains are calculated, when an asset is sold. In this strategy, losses can be intentionally captured on paper and used strategically to offset taxable gains in your non-IRA portfolios. Tax loss harvesting reduces your overall tax liability and allows you to rebalance your portfolio by reinvesting in assets aligned with your financial objectives.
Roth Conversions
Converting some dollars in IRAs to Roth IRAs is a winning strategy during periods of volatility. A Roth conversion is later bucket-focused – realizing taxes now to shield dollars from taxes later. Should Roth conversions be part of your plan, consider converting during periods when the stock market is down, as this can help you save money on taxes and maximize tax-free growth. Converting money from an IRA to a Roth IRA will result in income tax liability on the amount converted. If we do this during periods of market volatility, that is no exception. However, if the share price is reduced, there is less to pay in taxes. The stock market often acts like a roller coaster, bouncing back from periods of volatility during every preceding market decline in history (although the time it takes to recover has varied). It is lovely to witness that recovery through increased share prices occurring in the tax-free environment of the Roth IRA. Essentially, this strategy results in less taxes paid and more tax-free growth.
Although market volatility can be painful for investors, we encourage you to stay the course. As Warren Buffet said in his 2017 letter to shareholders, quoting Rudyard Kipling’s poem “If”: “If you can keep your head when all about you are losing theirs ... If you can wait and not be tired by waiting ... If you can think — and not make thoughts your aim ... If you can trust yourself when all men doubt you ... Yours is the Earth and everything that’s in it.” Maintaining composure and seeking opportunities when fear grips others is a formula for long-term success.