The Bear Market Playbook
June 24, 2022
This month, we officially entered bear market territory. (And unfortunately, that does not mean we’ll be running into Yogi with his picnic basket.)
With a peak in early January of this year, the market has been steadily declining for the past six months, and recently hit a 20% drawdown from peak to trough. (As of the writing of this blog, it’s down 23% from the high.) With this six-month stretch and more than 20% drop, that puts us in bear market territory. With that, investors are wondering,
“How long will this last?”
That’s a question no one can answer definitively, but we can provide some perspective on this scenario based on past trends. There are also a few strategies that could help you take advantage of this otherwise unfortunate season. But first, let’s review exactly what we’re dealing with.
The History of Bear Markets
Recently, RBC released some market research about peak-to-trough declines around recessions. When they studied them, they found that on average, the market loses about 32% of its value prior to a recession. They also found that the average pullback (i.e., decline in the market) before a recession lasted about 381 days.
So what does that mean for investors today?
While history isn’t guaranteed to repeat itself, these statistics are a good indicator of what might happen in the coming months. So if you think we’re experiencing an average pullback, that means we’re about two-thirds of the way through and we might have another six months or so before we start seeing stocks move in the other direction.
There is Good News
That may not sound like great news today, but fortunately, there’s always tomorrow (or, more accurately, next year). Statistics from Charles Schwab show that on average, the returns one year after bear markets were around 15%, and the average return three years after bear markets were around 30%.
So, while no one knows how long we’ll be in this bear market, if we look at past trends, things likely aren’t going to stay this way forever. And if we wait it out, then a year or three years from now, investors could be very happy they stayed in the market (or even invested more during the pullback).
If you have excess cash and you’ve been waiting for the right time to buy, now might be a good time to start reaching into the proverbial picnic basket. And if you’re already fully invested, then “sitting on your hands” might not be a bad idea.
5 Ways to Take Advantage of a Market Pullback
Bear markets—though they tend to invoke panic and fear and a host of less-than-savory news headlines—are not all bad. In fact, there are several ways you can use them to your advantage. Here are five:
Tax Loss Harvesting: If you own a stock in a taxable account and it’s down from where you bought it, you may want to consider buying a similar stock or fund and realizing the loss. This is why: let’s say you owned the S&P 500 and it was down 10%, and you had some loss you hadn’t yet realized. You could sell that stock and buy a similar fund (like a total stock market fund). As far as growth, the new fund would probably behave similarly, but it would affect your taxes differently. By realizing the loss, you could either offset some of your income for the tax year (up to $3,000), or, if you have more than $3,000, you could offset future capital gains in later years.
Roth Conversions: If you’re at a point in life where converting funds to a Roth makes sense for you, now might be a good time to do so, because you could pay lower taxes on the conversion. Let’s say you have 100 shares of XYZ stock, and it trades at $100 a share before the bear market. If you were to transfer that money to a Roth before the pullback, you’d have to pay taxes on everything you converted, which would likely be around $10,000. But if you convert those same shares when the stock market is down, say, 30%, and your shares are worth just $7,000, you’d only pay taxes on the $7,000. Then, if and when the market recovers, your 100 shares would grow tax-free.
Giving: Similar to the Roth conversion strategy, gifting your assets during a bear market can also be beneficial. Using the example above, if you give 100 shares of XYZ stock while it’s down 30%, that means you’re technically giving away $7,000 rather than $10,000, so it counts less against your gift exemption. Essentially, you get to pay fewer taxes while giving away the same number of shares.
Over-Rebalancing: Let’s say you currently have a 50/50 allocation of stocks and bonds and the market drops 23%. It could be a good time to get more aggressive with your allocation. You could rebalance your portfolio to 60 or 65% in stocks while prices are low, and then in several years, if you see decent returns, rebalance your portfolio back to 50/50.
Systematic Saving: This is another fancy way of saying, “buy low.” If your budget allows, try increasing your investment contribution. Instead of putting 7% in your 401(k), shoot for 8 or 9% while stocks are “discounted.” Then, in a few years, if we see the strong returns as we have with other bear markets, you’ll be glad for the extra money you put aside during the tough times.
Don’t Let Fear Guide You
Whatever you do, don’t let panic, fear, or doubt be the driving force behind your investment behavior. If you change your portfolio allocation, it should be because something in your life (your priorities, goals, or circumstances) changed, not because the market changed.
That’s why it’s important to always have a strategy in place—and not deviate from that strategy unless life events prompt you to. If you need to access money from your assets, your plan should already account for that, bear market or no. And if you’re in growth mode and don’t need access to your investments for the next five years or so, then try not to worry—you can use this opportunity to accumulate more, and in several years, you’ll likely be glad you did.
Talk With a Professional
If you’d like to know more about bear markets and how to navigate them, we’d love to talk with you. You can schedule a consultation with one of our advisors here.
*Asset allocation does not protect against loss of principal due to market fluctuations. It is a method used to help manage investment risk. Please note that all investments are subject to market and other risk factors, which could result in loss of principal.
*This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.
*This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources