One thing we keep hearing from the financial press and our competitors is that the best thing for clients to do in a bear market is nothing.
However, we think there is a big difference between “doing nothing” and not “panic selling.”
In political circles they say, never let a good crisis go to waste. Investors must remember, never to let a good bear market go to waste.
As long-term investors we embrace bear markets. Why? Because bear markets provide several opportunities for savvy investors. We can upgrade the quality of the holdings. We can dollar cost average at lower prices to increase long term returns. We can generate tax efficiencies that will mitigate capital gain taxes and allow us to tax efficiently rebalance our portfolios.
We love to use bear markets to upgrade our portfolios. In a down market, the only thing that goes up is correlation. That means that when investors panic, they don’t discriminate between a high-quality business with enduring competitive advantages and a weak dying business. Panicked sellers just want to be in cash, and everything goes down in similar magnitude. We take advantage of these periods to buy high quality names on sale. This is a rare opportunity, that can’t be missed. In a rational market, these companies most often trade at a premium.
Bear markets are also an opportunity to put cash to work. For workers they are a great time to increase 401k contributions to the max or make after tax contributions to IRA’s or Roth IRA’s. Bear markets are usually an excellent time to pull forward 529 contributions for children or grandchildren. The IRS allows you to make multiple years of contributions at once. Since the beneficiaries usually have a long-time horizon making larger contributions into a down market should result in better returns and more money available for the beneficiary’s educational needs.
Finally, bear markets offer tax mitigation opportunities. The growth in the number of ETF’s exposed to the same market trends, despite differences in actual holdings, has increased and simplified the availability of tax loss harvesting opportunities. Investors can sell investments which are down from their entry point, bank those losses to use against future gains, and enter securities similarly exposed, with relative ease. These banked “tax losses” can be used to rebalance portfolios without incurring tax on sales of appreciated investments. These tax savings result in extra capital in client’s accounts which multiply in value as they compound. Even small tax savings can have a substantial impact on your account when compounded over many years.
When you hear “experts” and other advisors tell you to not check your account or to do nothing in a bear market they are doing you a disservice. What they really mean is, don’t panic sell or try to time the market by going to cash. But that should only be half the advice. The other half should be, “upgrade your portfolio,” “increase your contributions to 401k’s, IRA’s and 529’s, and “make sure to harvest your tax losses”