How to Make the Most of Down Markets
By Daniel Campbell, CFA
If you have been keeping a pulse on markets, you’ve seen the significant price swings so far this year. The S&P 500 has moved by 2% or more on 19 days already, while this only happened seven times in 2021¹, and it moved by more than 3% on five days, which didn’t happen at all last year. The higher volatility simply means that stocks and bonds are experiencing above-average price changes, with big declines some days and large recoveries on others. Although this can feel scary as your portfolio value fluctuates, this can also be one of the best times to build wealth.
When stocks and bonds are trading at much lower prices, we like to say they’re on sale. The price-to earnings ratio for U.S. stocks, a measure of how much a dollar of earnings costs on average, has gone from 23.9 at the beginning of the year to 19.1 at the end of May². Bond yields are also higher than they have been for a few years, with the five-year Treasury bond yield near 2.9% compared with less than 1.4% at the year’s start³. That means stocks and bonds are now a better value—and we expect greater potential for future returns.
For many of our clients, we have already taken advantage of the price changes by rebalancing portfolios and tax-loss harvesting, as appropriate. Rebalancing offers a disciplined approach to the phrase “buy low and sell high,” allowing us to move more money into the asset classes that are down the most. Tax-loss harvesting involves selling positions for a loss and moving into a different fund that targets a similar strategy. This approach realizes losses and may reduce your tax bill.
But what else can you do to take advantage of the down markets? Here are three options to consider:
Increase contributions:
If you are making contributions to any account—such as your company retirement plan, a personal IRA or even a trust—consider increasing the amount. Alternatively, if you’re comfortable with the risk that markets could decline further, you could move planned contributions to earlier in the year. Adding money now means you can benefit from the recovery when it occurs.
Convert an IRA to a Roth:
This may be a good time to convert a traditional IRA to a tax-free Roth IRA. Although you need to be conscious of the rules around Roth conversions, with which your advisor can help, you could save on income taxes for the amount that you convert since prices are down. Doing so would allow any market recovery to be captured in a tax-free account.
Set up, or add to, a 529 plan:
If you plan to help your children or grandchildren with future education expenses, consider establishing a 529 plan for them—or adding to it if you already have one. Establishing the account now means your initial investment can take advantage of lower prices.
If you are nervous about investing during volatile or down markets, that’s OK, too. Many people like to invest a little over time, a technique known as dollar cost averaging. Because markets tend to go up during longer periods, this strategy doesn’t tend to be additive in terms of total returns to the total portfolio. But if setting a disciplined investment schedule helps you move out of cash, this can be a far superior approach than not investing at all.
¹ Source: Yahoo! Finance. As measured by the percent daily price change in VOO – the Vanguard 500 Index ETF. As of June 3.
²Source: Morningstar Direct. Based on the Russell 3000 Index. Valuations as of the end of May, retrieved June 5.
³ Source: Bloomberg, as of June 3.
For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results. Total return includes reinvestment of dividends and capital gains. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article. R-22-3970
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