Money Talk: Strategies to shore up retirement even in declining market
It is perfectly normal for investors to get nervous when stock market volatility raises its ugly head. For young investors, stock market downturns should be welcomed as they present an opportunity to add to their stock portfolio when stocks are on sale simply by continuing to make their regular payroll contributions to their 401(k). Young workers have ample time for the market to recover and provide the expected, long-run, inflation-beating returns. For older workers and retirees, it can seem like their retirement fortunes are completely out of their control when markets get volatile. While understandable, it is important to remember that there are still opportunities to make lemonade when the stock market appears to be serving up nothing but lemons.
Currently, investors with stocks and bonds in their portfolios, have seen an unprecedented start to a calendar year. The US stock market has seen one of its worst days since 1995 and bonds have seen one of the worst calendar year starts for their returns in decades thanks to rapidly rising inflation.
These downturns, however, need not derail an investor's strategy. In fact, those who have stuck with their portfolios through volatile times have likely seen the best returns over time. In fact, staying the course is likely the best strategy for shoring up a retirement portfolio in a declining market. Emotionally, this can be a difficult path, even for advisors. I cringed at a recent Facebook post that came through one of my friends' newsfeeds. The commentor said that her advisor had recommended she move her entire portfolio into "stable bonds." This might have felt good since something was being done in response to the stock market decline. The problem is that the better advice is likely to be exactly the opposite. Yes, bonds are cheaper than they were a few months ago, but the upside in stocks will likely come sooner and stronger than any upside in the bond market since the latter will require a declining inflation, declining interest rate environment.
For perspective, Invesco recently released commentary that looked at potential returns for investors who invested $100,000 in the S & P 500 Index in 1995 and either held on throughout or added or withdrew funds from their portfolios after each of the 54 worst trading days. The buy-and-hold investors would have seen their $100,000 grow to just over $900,000. Investors who withdrew just $1,000 after each of those days would have a portfolio worth just $711,000 while those who added $1,000 would be sitting on $1,095,000. That is a big difference in long-term returns for just small responses to market declines. Imagine how much worse it might be if an investor put their whole portfolio into "stable bonds" after the first downturn.
This should give young investors food for thought. Can you add more to your 401(k) when the stock market is on sale? Even older investors should consider whether they have excess cash that is out of stocks that could be used to add to their stock portfolio. Rebalancing into stocks in down markets is one of the best ways to boost returns.
For investors who are comfortable with their cash safety net, stock downturns can still provide opportunities that will payoff long-term. Market downturns offer a couple of nice opportunities to improve an investor's long-term tax situation. Converting some pre-tax retirement funds sitting in traditional IRAs to Roth IRAs can be an excellent strategy to both hedge against tax rates rising in the future and take advantage of the stock market recover (yes, it will recover). Look to fill up your current tax bracket by moving stock investments (whether individual stocks, stock mutual funds or exchange-traded-funds) in-kind to your Roth IRA. You pay tax this year on the value of the shares moved over, but you lock in today's tax rate and future growth can be withdrawn tax-free after the Roth holding requirements are met.
Another tax strategy to consider when stocks are down is tax-loss harvesting. This approach is designed to maintain an existing investment allocation but gather losses that can be used to offset realized capital gains (or gains that may be distributed by mutual funds). Losses not used to offset capital gains can be used to offset ordinary income (up to $3,000) with any excess carried forward to future tax years.
David T. Mayes is a Certified Financial Planner professional and IRS Enrolled Three Bearings Fiduciary Advisors, Inc., a fee-only advisory firm in Hampton. He can be reached at (603) 926-1775 or david@threebearings.com.
This article originally appeared on Portsmouth Herald: Money Talk: Strategies to shore up retirement even in declining market
