Bear market What (if any) should you do? – The White Coat Investor : INVESTMENT

[Update just prior to publication: I’m trying to get you guys some up to date content, I really am. I literally just wrote this a few days ago. Of course, in the last three days the market has climbed 20%, which according to the WSJ, actually marks the END of a bear market. Nonetheless, chances are good that markets will continue to be highly volatile for at least a while and there are likely to be more big drops as the market tries to figure it all out. So hopefully the post is still useful. Otherwise, I’ll just trot it back out in 2 or 3 years when we hit the next bear market. Stay safe out there!]

I’ve written a lot of posts about bear markets over the years. Here is a quick example:

We will have or will publish most of them again soon. Given that this is the largest bear market since 2008 (and maybe even bigger when everything is said and done), it seems appropriate to write something new for you on the subject. So I thought I would write a comprehensive post on bear markets, what you should and shouldn’t do during those markets. I will also add some CoronaBear specific information.

General bear market advice

Let’s start with some general bear market advice. This stuff pretty much applies to every bear market.

# 1 Stay on course

I have been asking people for years to come up with a written investment plan. I wasn’t joking. One of the best reasons for a written investment plan is that if you have a question about what to do with your investment, you just have to go to the plan to remember what to do. A good investment plan should look at what you would do in the case of a bear market. Historically, a bear market occurs about every three years (20% + decline in stocks). It is an expected event. If you have a 30-year career and 30 years of retirement, you are an investor for 60 years and you should expect to go through around 20 bear markets. Bear markets are expected events; You shouldn’t be surprised by them. Your plan must take them into account. You need a plan that is likely to be successful among a variety of future business opportunities. My special investment plan (you know the one we designed as residents and who made us financially independent multimillionaires) gives us this instruction on bear markets:

Personal explanation for Jim and Katie Dahle Revised July 29, 2007

… .We will not panic and sell securities due to market corrections… We will rebalance our asset allocation as often as necessary according to the 5/25 rule and use as much new investment money as possible… .All major changes to this IPS will be required three months waiting for another test….

Here we go. If I ever wonder what to do when the market is 10-90%, I can reread that statement and remember that I won’t sell due to market corrections. In fact, it says we will buy during market slumps to rebalance our portfolio.

It seems like a good time to pull out this classic Jack Bogle quote:

I have said “Stay on courseA thousand times and me meant it every time.

Would you like to learn more about how to keep the course or create a written plan? Check out these posts:

# 2 rebalance your portfolio

Rebalancing does not necessarily increase returns in the long run (since you normally trade higher yield stocks for lower yield bonds), but it does ensure that you keep your portfolio risk at the level you originally selected. There are many ways to do this, but the most common is to do it on the same day each year, or if the portfolio differs significantly from the asset allocation specified. The best thing about realigning your portfolio is that you are forced to sell high and buy low. If you have to do anything during this bear market, this is probably the best thing you can do. Your written investment plan tells you how to do this. More contributions to the compensation here:

# 3 Tax loss

I covered this extensively earlier this week, but this is a great way to make lemonade from lemonade. In essence, you can share your losses with Uncle Sam in a taxable account. You can book a taxable loss that can offset an unlimited amount of capital gains and a decent income of up to $ 3,000 a year by swapping an investment for a similar but not “essentially identical” investment. You are not selling cheap because you are still fully invested in the market. More details in the following articles:

# 4 Make sure you have enough money

Bear market

In Alaska, you carry a gun while hiking. When investing, you have a written investment plan. Both will help you deal with bears.

Bear markets are often accompanied by recessions, and recessions are often associated with job loss or a drop in income. In such situations, cash can be very useful to prevent you from having to raid assets that have temporarily decreased in value. In essence, it keeps you from selling your stocks low and selling your property at fire sale prices. An emergency fund typically consists of spending 3 to 6 months in easily accessible cash. Don’t be tempted to use this money to “buy stocks for sale”. Make sure you know what you really need. If you have more than that, feel free to invest it, but don’t invest your emergency fund in stocks. The market can keep falling. Cash is king, but it is limited. Use it wisely.

# 5 Check your risk tolerance

I often ask young investors to recall their proposed asset allocation until they have gone through their first major bear market. Now you are in your first big bear market. Pay attention to how you feel when you lose real money that you used to have – money you invested instead of spending on a kitchen renovation, a trip to Paris, or a Tesla. Okay sleep? If so, you can increase the risk in your portfolio a little, but at the end of the bear market (the market can keep falling). If you’re nervous about your investment and don’t sleep well, aren’t you glad you followed my advice? If you are a psychological basket with these losses, you are not selling everything. Sell ​​to your sleep point and stay there. Congratulations! You have found your risk tolerance. Unfortunately, it cost you some money.

# 6 Don’t look

Most of us are pretty good at ignoring their investment accounts for weeks or even months. That’s probably a good thing. It gets more difficult when the headlines talk about massive stock losses. Your risk tolerance is probably higher if you simply avoid looking at your accounts during these times. Destroy your bank statements sent by post without removing them from the envelope. Let yourself be excluded from your online login. Whatever is necessary. Just stay on course.

Pandemic specific advice

Every bear market is unique and it is no different. But they all end the same and I assure you they all end. If it doesn’t end, it doesn’t matter what you do with your investments anyway, since you’re in a post-apocalyptic scenario. There are some interesting aspects, but it is worth spending a few minutes on them.

# 1 Your mortality rate is higher

The first is somewhat macabre to discuss. But healthcare providers, like many of the high-income professionals who read this blog, are more likely to get corona viruses. Many of them are middle-aged or older and are at higher risk of dying than younger people. Most doctors I spoke to feel like soldiers going to war zones every time they go to work. There are some financial planning considerations that you may not have considered. I hope that the new terror that is inherent in your daily work provides enough motivation for it. These include:

  1. Disability insurance (if not financially independent)
  2. Take out life insurance (if someone else depends on your income)
  3. Get a will on the spot
  4. Carry out all other necessary estate planning tasks

# 2 Your income is lower

As a rule, doctors have a very recession-proof business. People get sick and injured about the same number of times, regardless of whether economic times are good or bad, and they often use a third-party payer to pay for your services. However, in this particular pandemic, almost all dentists and many doctors are at home with everyone else. Even those who are still working do it by phone and video and are paid less, if at all. The volume of the emergency room has also decreased as patients are instructed to stay away from the hospitals.

Fortunately, your expenses are almost certainly going down as restaurants, cinemas, concerts, plays, school events, and especially vacations, are gone. However, unlike most bear markets, you may not have the money to make your regular investments, and even less, invest a little more to buy stocks for sale. You could consider other income-increasing activities, such as: B. surveys or telemedicine to partially offset your losses. It’s also not a bad time to start working from home, though many of them (like blogs and podcasts) are unlikely to generate income before you get back to work.

# 3 You have more time

Since you are probably working less than usual, you have a lot more time. We enjoy “resetting” with our children and can spend more time with them. Another great way to take advantage of this break in your life is to finally be financially savvy and create a written financial plan.

You have time to read some good books, take an online course, or video conference with a financial planner. You now also have time to review your insurance, review your estate plan, rebalance your accounts, refinance your mortgage, refinance your student loans (at least apply for and secure the interest rate, even if you are short term 0% / no wait for the payment item to end), or get advice on your student loan.

Use the opportunities of the bear market

# 1 buy things

If you’re lucky enough to have a steady job / income and lots of cash, this can be a good time to buy something you’ve been waiting for. There are probably not very many people shopping at home these days and the shops are terribly empty. These small business owners (and the overall economy) will be very grateful to you. Of course, you need to follow the relevant public health guidelines, but recessions are often a time to score a lot of points on all sorts of things. The car I’m still driving was bought in January 2009. We got a damn good deal because we were the only ones buying at the time. The same when we bought our house in autumn 2010. We looked at more than 30 houses and 6 months later when I checked that the only one that came out of the market was the one we bought.

# 2 Buy stocks instead of things

Okay, that will sound strange given the opportunity above, but a bear market can be a good time to delay purchases. If you suspend the house, car, renovation, vacation, or whatever for a year or two, you can use the money you saved to buy stocks for sale. Shelby Davis said, “You make the most money in a bear market, you just don’t notice it.”

Get rid of Legacy Holdings

Some people are stuck with “legacy stocks” in their portfolio when they weren’t as financially savvy. These are usually individual shares or actively managed funds. Once they knew what was going on, they decided to stick to these investments because they would suffer massive tax damage if they sold them and had to pay long-term capital gains taxes. They may have built their portfolio around them instead of using preferred investments, typically low-cost, broadly diversified index funds. Well, as the market fell, the tax cost of swapping these investments for something you actually want fell and may even go away entirely. Why not build the portfolio you really want when it doesn’t cost you anything?

# 4 overweight

Some people have included a provision in their written investment plan that allows them to strike a balance. This could be seen as a form of market timing or tactical asset allocation and requires a high level of risk tolerance, making it difficult for most to recommend. But well done, it can be very profitable. Basically it works as follows:

Let’s say your portfolio usually consists of 60/40 stocks of bonds. If the market drops 20%, you may adjust the portfolio to 70/30. So you are not just rebalancing, you are also overbalancing. If it then falls by 40%, set yourself to 80/20. If it drops by 60%, set it to 90/10. Make sure your written plan specifies how you will reverse this on the other side of the bear market. The big disadvantage of this approach occurs in an apocalyptic scenario where you zero the portfolio, but frankly, if the stock market goes zero, I wouldn’t expect much from your bonds.

# 5 Roth conversions

If you move money from a deferred tax account to a tax-free account (Roth account), this is known as a Roth conversion. You essentially pay in advance the taxes that you would have paid if you had withdrawn this money from your deferred tax account in the hope that it would lower your overall tax rate on that money. However, after a market crash, your deferred tax account will be smaller, so converting the same number of shares into a Roth account will cost less money. So if you’re planning a Roth switch anyway, a bear market is a good time for it. Typically, you want to pay the tax charge for the conversion from taxable assets, not the deferred tax account itself. As a result, money is moved from a taxable and unprotected account to a tax and asset protected account.

# 6 Reduce your estate taxes

If you have a probate tax problem, the best way to reduce it is to give your heirs regular gifts of $ 15,000 per person per year. It also helps to give away assets (through an irrevocable trust, annuity, limited partnership or limited liability company) before they are valued. If assets are worth less (i.e. on a bear market), use less of your inheritance tax exemption to give them> $ 15,000 gifts.

An example could be a Grantor Retained Annuity Trust (GRAT). This is an irrevocable trust where the grantor (rich old guy) puts money in the trust and then receives payments from the trust to continue for a certain number of years. At the end of these years, the beneficiary (young poor guy) will get whatever is left (usually the headmaster). Since the beneficiary does not receive the money immediately, it is not worth so much, so the gift uses less of the inheritance tax exemption than it will ultimately be worth. When the shares fall, they can be included in the GRAT, and all of these appreciations go to the beneficiary without reducing the inheritance tax exemption. A Grantor Retained UniTrust (GRUT) works similarly, except that the beneficiary receives the payments and the grantor ultimately receives the principal.

The principle is basically the opposite of charitable donations. You want to give more to charity when stocks are valued because you get a bigger tax deduction for it. But every time part of the money goes to your heirs (including some types of nonprofit trusts), it may be better to do so in a bear market than in a bull market.

Things you don’t want to do in a bear market

Finally, we should go through a number of things that you are likely to be tempted to in a bear market, but not.

# 1 Time the Market

It is so tempting to see the market rise or fall by 5 or 10% a day. Do not do it. You are an investor, not a trader. These are assets that you buy for the next 30 years, not the next 30 minutes. Follow your written investment plan.

# 2 day trading

The same goes for.

# 3 Buy individual stocks

It is no smarter in a bear market than in a bull market. They don’t know if an airline, a cruise ship, or an oil supply is only temporarily depressed or if it is on the way to bankruptcy. Just buy them all and keep them forever.

# 4 Buy actively managed mutual funds

If the fund managers had a working crystal ball, why didn’t they sell all of their stocks at the market high? Active managers cannot choose stocks better on a bear market than on a bull market. They are unlikely to do it well enough to overcome the long-term cost of it. They usually have a little more cash in the fund than an index fund, but that will (and mostly) hurt them more during the recovery.

# 5 Buy leveraged inverse ETFs

Buying a fund that works against the long-term direction of the markets is child’s play and requires a functioning crystal ball in order to do well in the long term. Adding levers only makes things worse. Avoid leveraged ETFs of any kind, especially in a bear market. They are not tools for long-term investors that you should be with your serious money.

# 6 Short the Market

Here is another common temptation on a bear market to close the market. If you sell a stock, ETF or fund short, sell it first and buy it later. I know it sounds a bit strange, but that’s how it works. The idea is that if the market was between the time you sell it and the time you buy it later, you were able to sell high and low. You actually have to borrow the securities to sell them, and borrowing is a significant source of income for index funds. Needless to say, borrowing is costly. Again, you are betting against the long-term direction of the market as you try to set the time. It is a recipe for disaster. You are probably better off at the roulette table.

# 7 Buy puts

If shorting the market is not adventurous enough for you, you can also bet against the market with options, especially put options. When you buy a put option, you do so at a certain price (the strike price) for the security (share or ETF). If the price of the security falls below the strike price, you can “set” it to the seller of this option at the strike price. Your profit is then the difference between the current price and the exercise price minus the associated costs. However, when you buy an option, it usually applies to multiple stocks. So if you spend $ 2,000 on a successful put option in a nasty bear market, you might get $ 10,000 or more. If the security never falls below the strike price, the option to completely lose your investment may expire worthless.

These extreme results are more like gambling than long-term investing and should therefore be avoided by the long-term investor with his serious money. Expect anyone who sells you a put option to be far better informed about this security than you. If selling the market short is like playing roulette, buying puts is like borrowing money from a payday lender to get into the World Series of Poker.

# 8 leave the stock market for “alternatives”

Whenever the stock market declines, people come out of the woodwork and say, “I told you.” It doesn’t matter what they sold before, they will point out that the value has not only decreased by 20-40%. You’ll hear this from everyone, from Bitcoin promoters to trend followers to life insurance sellers. But just like you never hear about the anti-Vaxxers during a pandemic, you will never hear from these people if the stocks are doing well, as is usually the case. Your screams are annoying, but these alternatives can be ignored if you follow your written budget. If you were convinced of the long-term benefits of owning stocks of the most profitable companies in the world (publicly traded stocks) before the bear market, there is no reason to change your mind as these stocks can now be bought at a lower price.

I hope these tips will help you smell like a rose on the other side of the bear market. This will also pass.

What do you think? What other bear market advice do you have for new and experienced investors? Comment below!

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