Watching your portfolio fall can be scary, but investors should resist the urge to drop everything and cash out in a hurry. The S&P 500 has fallen 18% this year and briefly fell into a bear market in Friday’s session — down 20% from its highs. The Nasdaq Composite, mired in a bear market, is down more than 29% from its highs. Blair duQuesnay, an investment advisor at Ritholtz Wealth Management, said: “Preparing for a decline in your portfolio is like putting on armor and preparing for battle so you don’t get a shock.” Follow these steps instead of letting fear drive your decisions . Sell wisely and reduce your tax bill Tax loss harvesting involves selling losing positions in your taxable brokerage account and then using them to offset capital gains realized elsewhere in your portfolio. If the losses exceed the gains, you can offset ordinary income by up to $3,000 per year. Don’t just sit on the cash from the sale. “Trade your position at a loss and buy something else that keeps you in the market with the same risk,” says Brenna McLoughlin, senior advisor at Wealthstream Advisors. That way, you can maintain your target asset allocation. Also, be careful when you choose investments that will be used to replace the losers you sell. This is because the IRS will prevent you from deducting tax losses if you sell a losing position and, within 30 days before and after the sale, you buy substantially the same securities as you sold. This is called the wash sale rule. The ease of finding alternatives will vary. “If you want to sell a large-cap U.S. fund at a loss, you can buy millions of funds to keep investing,” McLaughlin said. Bond funds can be more challenging because they are modeled on different benchmark indices, and investors need to weigh duration and credit quality when choosing alternatives, she added. Rebalancing Your Portfolio Last year’s big market rally resulted in a heavy weighting of stocks in investors’ portfolios. Rebalancing your portfolio gives you control over your asset allocation. “It’s a weird situation because stocks are down, bonds are down, so it’s not an obvious rebalancing opportunity,” Duquenay said. Find the biggest winners in your portfolio and earn some money from them, she adds. The S&P 500 energy sector is up 46% this year, including good contenders. Invest the funds from these earnings and restore the balance of your portfolio to where it needs to be. That could mean buying stocks at bargain prices. “That’s how you keep buying low and selling high without guesswork,” duQuesnay said. Is there an IRA? Convert It to Roth Investors can turn a declining traditional IRA into a tax saving opportunity by converting it to a Roth IRA. A traditional IRA allows you to invest pre-tax or tax-free dollars over time, but withdrawals are subject to ordinary income tax—a 10% penalty tax if you’re under 59½. If you convert your account to a Roth IRA, you will need to pay income tax up front. Funds in this account can grow tax-free and can be withdrawn tax-free under certain rules. Roth conversions are especially attractive during market downturns. “If you’re considering converting your IRA to a Roth, and the value is now lower, you’ll be taxed on that lower amount,” duQuesnay said. Once the shares are reinstated, you will receive the appreciation in your Roth account on a tax-free basis. “To be a long-term investor is to be a short-term pessimist and a long-term optimist,” she added. “Stick to your plan and keep investing.”
Even in a bear market, don’t let fear drive your decisions.What should investors do next
