Jennifer Baick
MBA, CFP®, CDFA Senior Director, Financial Planning Group
Summary
It can be tempting to adjust investments, but the wrong actions at the wrong time could damage your portfolio irretrievably.
A stock market sell-off — often called a drop, correction, decline, downturn, or crash if severe — can occur for various reasons, sometimes during a recession or in fear of one. A recession, as defined by the National Bureau of Economic Research, is a “significant decline in economic activity spread across the economy, lasting more than a few months.”
Regardless of the reason for a market drop, it’s natural for investors to feel unsettled and seek ways to minimize or recover losses. However, it’s crucial to remember that investing carries inherent risks, and focusing on long-term returns with a diversified portfolio is essential. Making drastic changes to your portfolio during times of uncertainty, like leaving the market or stopping retirement contributions, can have long-term negative effects.
For example, when the COVID-19 crash began on March 11, 2020, the S&P 500 lost more than 15% in two days, but one year later, the S&P 500 had gained 79%.1 More recently, on August 5, 2024, due to a market sell-off, the S&P 500 finished the day down 3%, but by market close on August 9, 2024, the S&P 500 had returns of 12.99% for the year — the volatility was a result of a combination of macroeconomic trends, not a single event or data point. Moreover, The S&P 500 has a median 25-year annualized return through 2023 of 10.40%; the high was 17.25% and the low was 7.56%.2
The worrisome feelings or impulses during a market decline should not be ignored, however. In recent years, behavioral finance has become a critical part of understanding psychological factors that drive investors’ decision-making. If there are adjustments being contemplated, making them productive could mitigate the negative effects of a market drop that investors may fear.
If you, or investors you know, have concerns about market downturns, here are four proactive actions to consider:
1.Turning market losses into tax savings
Tax loss harvesting. Review the stocks you hold at a loss and develop a plan to use the losses to offset your capital gains. This requires careful action, though, as you want to take the loss but not miss any potential recovery. You also want to avoid a wash sale, which is when you sell a stock at a loss but buy it again within 30 days.3 We recommend working with a financial or tax professional when considering potential tax advantages with this approach.
Roth conversion: Converting stock assets to a Roth IRA when market valuations are low allows you to move more assets from a taxable bucket to a tax-free bucket. Depending on your financial and portfolio circumstances, this approach could be enormously beneficial.
2. Staying invested while modifying plans
Contributions and buying opportunities. Market drops might feel scary, but they do generate opportunities to purchase securities at considerable savings. The popular saying, “Buy low, sell high,” applies here. And for those who’ve been sitting on the sidelines waiting to invest, this is their opportunity. Stopping or lowering contributions to retirement accounts or investment portfolios could result in lower returns overall.
Distributions. If you’re thinking about starting distributions from a retirement account, it may make sense to delay. It could be more prudent to take the distributions when the market recovers or consider spreading out the distributions. If you’re already making withdrawals, evaluate your portfolio by matching the balance to future cash flow needs. A cash flow–based financial plan can help prepare for downturns in the market by looking at future liabilities and adjusting withdrawal timing and amounts to help ensure there are sufficient assets to cover the expenses.
3. Assessing cash flow and future liabilities
Discretionary spending. Review your budget to identify how much is being spent on discretionary items. This exercise can help determine how much you might be able to apply to emergency or unexpected financial needs and help identify the best asset source for funding future obligations.
Retirement readiness. If you’re planning for retirement within the next five years, get as much clarity as possible regarding future expenditures. Negative returns in the early retirement years can have a more substantial impact on financial planning outcomes than those that occur later in retirement.
4. Exploring gifting and estate planning strategies
Gifting options. If significant asset losses occur, such as when there’s a market drop, it may be the right time to evaluate gifting to help minimize tax burdens. Keep in mind that many tax exemptions enacted with the 2017 Tax Cuts and Jobs Act are scheduled to end before Jan. 1, 2026, unless Congress extends them. Because gifting laws are quite complex, consult a financial or tax professional who can help develop a strategy.
Extending legacies. Like the gift tax, inheritance and estate tax is calculated on total asset values. Depending on the value of your estate, you might consider arranging an advance on a future inheritance to your heirs — gifting it to them while you’re alive and assets are lower, which may reduce their inheritance tax. Again, tax and estate professionals can offer guidance.
Learn more
Financial planning and investment strategies during a market down-turn can offer meaningful ways of improving your financial position if they’re executed properly and with professional advice. Channel the eagerness to act into potentially advantageous actions. More importantly, be prepared ahead of a major market or economic event, by having a financial plan and portfolio diversification, to help protect you from major losses.
If you aren’t a Mercer Advisors client and want to know more about keeping your portfolio on track with a trusted advisor, a well-crafted plan, and a diversified portfolio, let’s talk.
1.“A stunning fall and a recovery: How the stock market has evolved one year since Covid hit,” CNBC, March 12, 2021.
2. “S&P 500,” Wikiwand, Aug. 1, 2024.
3. “Watch Out for Wash Sales,” Charles Schwab, March 28, 2024.
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All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Diversification and asset allocation do not ensure a profit or protect against a loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Hypothetical examples are for illustration purposes only. Actual investor results will vary.
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