Investing Strategies to Utilize During a Down Market

TRICKS OF THE TRADE

Strategies for Investing in a Down Market

Prepared by: Kyle Ryan, CFP® & Michael Menninger, CFP®

This year is shaping up to be one of the worst in U.S. history for the performance of a balanced 60% stocks and 40% bonds portfolio. The rapid onset of inflation, subsequently followed by interest rate hikes by the Federal Reserve and coinciding with geopolitical events unfolding worldwide have left the market in a fragile state – filled with fear and uncertainty. With the market in such a frenzy, many investors are wondering what strategies they can use to take advantage of this historical bear market. In this article, we will review investment management strategies that investors can use to seize the opportunity of a down market.

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Roth IRA Conversions

We have covered Roth IRA conversion in previous Tricks of the Trade articles and on TV episodes of ‘Financial Planning: Explained’, but the value of a Roth IRA Conversion is even greater in a down market. If one wished to convert funds from a Traditional IRA / 401(k) to a Roth IRA / 401(k), he/she would be able to convert (and pay tax on) more shares for the same dollar amount due to the fall in stock and bond prices. When the market recovers, investors will participate in the recovery in their tax-free Roth IRA, thus maximizing the value of the conversion.

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Tax Loss Harvesting

Investors with non-qualified investment accounts that have unrealized capital losses can take advantage of a down market by selling investments that are down and receive a tax deduction for the loss. The proceeds of the sale must not be reinvested in that same investment for at least thirty days to qualify for the tax deduction. The proceeds can, however, be reinvested into another investment or left in cash in the meantime. These losses can be written off against your income or against capital gains that may be incurred in the future. This can be a powerful way for investors to take advantage of a down market and save money on taxes. Note that the IRS limits the amount of capital losses to $3,000 on your tax return each year, but excess losses can be carried over to future years.

Dollar Cost Averaging / Limit Orders

The adage, ‘buy low and sell high’, seems obvious, but is quite difficult to put into practice. The impact of emotions on investing tends to get in the way of this, as history has shown that the best time to buy into the market is when investor sentiment is at its worst. How can one overcome the emotional battle of buying into what seems like a free-falling market? 

A good option for investors is a strategy called dollar cost averaging (DCA), which is when one invests his/her money in equal amounts at regular intervals, regardless of which direction the market is moving. Over time, this can help investors acquire more shares of an investment when the price is low, and purchase less when it is relatively higher. This is particularly effective in a volatile market, as it removes the emotional resistance to purchasing and helps establish a habit to focus on the long-term objective of the account.

An alternate option for investors in a volatile market is to set limit orders below current market prices. A limit order allows investors to enter the market only if his/her investment of choice reaches the set limit price. This can be advantageous for investors who wish to participate in the market, but only by getting in at a price he/she deems attractive.

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