How to Survive a Manic Market
The closing bell on Wall Street Friday put an end to one of the most tumultuous weeks in stock market history, with the Dow literally setting a record: This was the first time it had moved more than 400 points on four straight days. Other than TGIF, what can we take away from the wild ride? One lesson is that what goes down often comes up. Despite the stomach churning drops on Monday and Wednesday, the Dow was down just 1.5 percent on the week. But it was a painful trip. We turned to fee-only financial advisor Gary Schatsky, founder of objectiveadvice.com, to tell us what to do now.
When they see the market plummeting, it's tempting for investors to just sell everything. Should they?
Unless you know something that all the pros don't know - namely that all your stocks will go down and continue to go down - making such a rash decision is almost completely driven by emotion and devoid of analysis. For some people, reducing their stock exposure might make sense, particularly if they were overweighted in stocks. But it is very much based on individual analysis, plus you need to consider the tax consequences.
It's the same sort of thinking operating in reverse for people during a rising market, who thought they should put all their money into stocks, and in fact borrowed to put money in the market. All of a sudden you are not only second guessing the experts, but you are not diversified if you put everything, or nothing, into stocks.
So when the market goes haywire, should we just do nothing?
If there is something good to be said about a calamity such as we've been experiencing over the last two weeks, it's a wake up call for people to people who might have been complacent about how their portfolio is allocated. People should review their overall asset allocation, they should review whether they have taxable gains and losses, and whether they might take advantage of some of those tax losses. And review whether they might have too much or too little in the stock market. Many individuals who've been on the sidelines for many, many months and have very little in stocks might view this drop as an opportunity to add to their stock holdings. Others, who have been overly optimistic, unwilling to reduce their equity exposure, might have to recognize that having to much in anyone asset is a mistake.
Have you had any clients who want to sell everything?
Yes, a few have insisted on selling despite my advice, and my comment to them is this: "The only time you'll be willing to rebuy is when the price gets up over the price you sold your stocks for." Now that doesn't mean you don't sell something....if you have too much in equities, or the expenses are high, or there's an opportunity to take that tax loss. But a knee jerk reaction would be a mistake, unless you happen to know something about the future that no one else does. And if you do have that knowledge, please contact me immediately.
How should someone should go about tax-loss selling?
As I often say, the tax code is your friend. It can mitigate the pain of losses if you are investing outside a retirement account. If you bought a mutual that dropped 20 percent -- you paid $10,000 and sold it for $8,000 -- that $2,000 of loss can reduce your tax liability. You are able to use losses to offset any investment gains, so you pay no taxes on those gains. And then, to the extent that your losses exceed your gains, you can offset your taxable income with those losses up to $3,000 per year. Any amount of losses you don't use gets carried forward into future years until you use it up or die.
So for people who might not have a heavy weighting in stock, there's still opportunity - they might sell a mutual fund, take a tax loss, and then buy another that has almost the same stocks. Your exposure to the market remains almost the same, but while you're waiting for stocks to go up, the tax code is easing the pain by saving you on taxes.
The unfortunate aspect of this is that if you have losses in your retirement account, those are not tax deductible.
What are you hearing from clients?
People are concerned, as they should be. They want to revisit their asset allocation. I'm getting a fair number wondering whether they should sell everything, and interestingly, an equal number wondering whether they should put everything in the market at lower prices. I think it reflects that people feel the need to act forcefully in times like this. But for a fair number, doing nothing might be the right choice. Obviously my clients are constantly having their portfolios looked at, but there's a broader cross section of people who make an investment and they barely look at it at all. Or if they do look at an investment, they still aren't looking at their overall financial picture. And that's really what this should prompt people should do.
We've been focusing on the markets, but are there financial steps people ought to consider outside of their investment portfolio?
Absolutely. Take a look at what debt you might have. Along with this market meltdown as come even lower interest rates. For people with mortgage debt, they might want to refinance. Or they might take money from a money market account earning very little and pay down debt. Effectively that earns them a higher interest rate. Why do you need to pay a bank 5 or 10 percent when you have money lying around earning very little?
Do you any particular opportunities in this manic-depressive market?
Market inefficiencies tend to show themselves in foreign stocks and small company stocks. There aren't the legions of analysts following these companies in the way they follow large American stocks. Shares of IBM and GE don't get wildly out of line from their value without legions of people saying hey, here's an interesting opportunity. That's less the case with smaller stocks and international stocks. I'm normally favoring well-managed, low-cost, no-load mutual funds. There might be a slight increase in some of that exposure.
Help our readers sleep a little better tonight: What can you tell investors to calm them down?
You can't calm down until you've analyzed your situation. If you've analyzed your asset allocation, your debt structure, your tax situation and you have a reasonably balanced portfolio that includes stock market exposure, you should be in good shape. Over longer periods of time we expect the markets to rebound, and a balanced portfolio will be key to your financial future. Then, you should sleep like a baby.
Thanks, Gary.
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