The Upside of a Down Market
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If you’re an investor, watching your retirement savings or investment portfolio lose value can be pretty unsettling. But it’s vital to remember that losses aren’t realized until you sell or trade — and that a downturn opens up potential opportunities, too.
It’s been a tough few weeks for the U.S. stock market, with the S&P 500 Index briefly falling into correction territory on fears of an economic downturn. But the market has generally gone up rather than down over the long run. If you believe it will bounce back again, there are plenty of ways to take advantage of potential bargains.
“Ups and downs are part of the deal,” Mark Fonville, Certified Financial Planner® and president of Covenant Wealth Advisors, wrote in an online post updated earlier this month. “Markets aren’t stable or steady over the short term, but they tend to perform consistently well over the long term.”
Depending on your risk tolerance, here are some possible ways to capitalize on a down market:
Buying the dip: When there’s an overall market downturn, your favorite stocks are essentially on sale. If you believe in the long-term prospects of a company, you could potentially make money by buying and holding shares of that company when prices are lower.
Similarly, if you’re invested in broad-based index funds, you might benefit from a recovery. Analysts at Goldman Sachs said last week they don’t expect a recession and would “use a deepening drawdown to ‘buy the dip,’” Seeking Alpha reported.
One word of caution, though: There’s no way to anticipate the bottom, so it’s possible stock prices could fall further before they rise again.
Dollar-cost averaging: If you’re a long-term investor making fixed and regular contributions to a retirement account, you’re doing what’s known as dollar-cost averaging. When the market is falling, you’re making the same investments but at lower prices, setting yourself up for future gains if the value of your investments increase.
Dividend reinvestment: If you’ve chosen to reinvest your dividends in your investment accounts, you’re getting more stock for the money in a market decline. And, for the same reason, it could be a good time to consider buying additional dividend-paying stocks.
Tax-loss harvesting: There are often more tax-loss harvesting opportunities in a down market. By selling investments that have lost value since you bought them, you can offset gains on investments that have increased in value and potentially lower your overall tax liability.
Roth IRA conversions: Investors convert traditional Individual Retirement Accounts or 401(k) plans to Roth IRAs to set themselves up for tax-free growth and withdrawals in the future, when, ideally, they will be in a higher-income tax bracket. Since conversions require paying tax on the accounts now, converting when the value of the account is lower can potentially reduce the amount of tax owed.
So what? Investing always comes with risk. But downturns present opportunities for investors who believe in the long-term growth prospects of the stock market. According to Covenant’s Fonville, despite all the corrections and crashes over the past century, a single dollar invested in 1926 in the S&P 500 predecessor grew to be worth about $17,000 as of last month.
Related Reading
• How to Survive a Stock Market Correction: Avoid Doing These 5 Things (Bankrate)
• What Past Stock Market Declines Can Teach Us (Capital Group)
• What You Need to Know When the Market Is Down (SoFi)
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