What do you do with your stocks when the market goes down—a lot? If you’re like most people, your first instinct is to sell. It’s human nature: When your investments go up in value, it feels great. When your stocks go down, so does your faith in them, and you’re tempted to dump everything and hide your money under your bed.
But investing is a long game, and seasoned investors know that, over time, market drops can be nothing more than a minor correction. You don’t want them to derail your investment plan. In fact, you might consider investing more when the market is down.
As a Certified Financial Planner™, my job is to help people make good financial decisions. When markets take a tumble, this often means that your best move is to keep calm and carry on investing.
Time in the Market Beats Timing the Market
Remember in 2009 when the stock market was down and everyone started selling everything off? Many of those who panicked, sold, and did not reinvest have never recovered. In July of 2007 the S&P closed at a high of 1526.75. Even if you sold there—never mind at the crisis low of 735.09—you would have missed a significant rally. On August 14, 2017 the S&P closed at 2464.61.
I won’t kid you—that 50% drop was terrifying. But if you panicked and sold, you would have missed the recovery.
Of course, in an ideal world, you would always buy at the bottom of the market and sell at the top, but since we are mere mortals who can’t predict the future, probably the next best thing is to hold on to our stocks over time. New York Times columnist Carl Richards drew this illustration of how market timing generally works in the real world.
Understanding Dollar Cost Averaging
To help curb your impulse to pull out of the market when it is low—and continue investing instead—consider the idea of “dollar cost averaging.”
Here’s how it works: Every month, you invest the same amount of money. Each month, that amount you invest buys different amounts of shares, based on the current cost of each share.
For example, let’s say you invest $100 a month. In January, that $100 might buy 10 shares of a mutual fund at $10 a share. In April, the market dips, and the fund’s shares are worth just $5. Instead of panicking and selling, you continue to invest your $100. That month, your $100 buys 20 shares. In June, when the market rises again, the fund costs $25 a share, and your $100 buys four shares. Let’s say that after 10 years of investing $100 a month, the value of each share is $50. Even if some shares you bought cost more than that, historically investors often average a lower cost per share than the current price of the fund.
Like I said, investing is all about time. Steady investments over time are more likely to give you a favorable return than dumping a large amount of money into the market and hoping you timed it right.
Tax Loss Harvesting
When the market turns sour, consider tax loss harvesting. I know your eyes started to glaze over the second you saw the word “tax,” but bear with me for a minute here. It’s important for investors to manage their taxes because they can take a bite out of your returns.
Tax loss harvesting is the practice of selling investments that experienced a loss in order to offset your gains in other investments. Imagine that you invest $10,000 in a stock in January. Over the course of the year, the stock decreases in value, and at the end of the year, it is only worth $7,500. Instead of wallowing, you can sell it and reinvest the money in a similar (but not identical) stock or mutual fund.
You get the benefit of maintaining a similar investment profile that will hopefully grow in value over time, and you can write off the $2,500 loss for tax purposes. You can write off the full amount against any capital gains you may have in this year or any future year. You can also deduct up to $3,000 of capital losses each year from your ordinary income.
During major market downturns this technique can ease the pain of capital losses—but it’s important to consider reinvesting the money you raise when you sell or you’ll risk missing the recovery. Keep in mind that investing comes risk, so there’s no assurance that a recovery will, in fact, occur.
It is human nature to be concerned, or to feel panic at times. Sometimes, the best investment advice is not to give in to your feelings. Investing in a down market can seem like a scary proposition, but it can ultimately be a part of a balanced investment strategy that helps you grow your wealth over time.
If you have questions about investing, SoFi financial advisors are here to help you—completely free of charge. Reach out to set up an appointment.
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