3 ways to take advantage of a market decline

No one knows how many lives will be lost due to the coronavirus pandemic, how many jobs will disappear and how long it will take for the economy to recover.

However, as a long-term investor, it is worth considering the following:

-        From 1949 to December 2018, the S&P 500 Composite Index has declined more than 10% about once a year, more than 15% about once every 4 years and more than 20% about once every 7 years.

-        No one can predict consistently when market declines will happen.

-        No one can predict how long a decline will last i.e., when the market will finally bottom and start to rise again.

-        No one can consistently predict the right time to get in or out of the market.

And most importantly:

-        In the past, markets have always recovered after the decline and continued to rise.

Also, consider this real fact (not a prediction): Since its inception in 1976, Vanguard 500 Index Fund has averaged a 12.4% gain over rolling 12-month periods. Interestingly, during the 12 months following the fund’s 10 worst months, excluding March 2020 (of course), returns averaged 22.2%, or almost twice the average. 

Therefore, market declines provide an opportunity for long-term investors. As a long-term investor, there are a few ways you can take advantage of a market decline, without having to predict the bottom or time the market.

Increase/adjust 401(k) and IRA contribution

Stocks are on sale! If you are contributing to 401(k) at work, continue to do so. It will enable you to buy stocks (preferably via a stock index fund) at lower prices. In this case, dollar cost averaging will result in lower average cost per share owned and higher potential capital gains when the market recovers. You may even consider increasing your contribution or adjusting your allocation percentages by increasing your stock allocation and lowering bond allocation. If you do not contribute to 401(k) or IRA, this is a great time to start!

Rebalance

The market decline may have resulted in a significant change in your portfolio allocation. For example, if your allocation before the market decline was 60/40 (60% stocks, 40% bonds), it may have changed to 55/45 or 54/46. Consider rebalancing your portfolio by moving some of the bond investments to stock investments (stock index fund), taking advantage of lower stock prices. As much as possible, be sure to do this in your tax-advantaged accounts - IRAs and 401(k) - avoiding any tax consequences. You do not have to rebalance all at once. Rebalance over time so that you can "dollar cost average" if the stock market declines over the next few months.

Tax Loss Harvesting

Tax Loss Harvesting involves selling an investment in a taxable (after-tax) account that has experienced a loss due to market decline and replacing it with a similar but more desirable investment to maintain your optimal asset allocation. For example, let’s say you are holding a stock or an underperforming actively managed mutual fund with high annual cost that you always wanted to sell but could not, due to potential taxable capital gains. However, after the market decline, the price of the fund has now fallen to a level that would result in a loss. You can now exchange this fund to an index fund and “harvest” the tax loss that can be used to offset other taxable gains and income. Note: Be aware of the wash-sale rule when using this strategy.

Related:

Using Vanguard’s Portfolio Watch and Portfolio Tester for Rebalancing

Using Vanguard Investor Questionnaire to determine your asset allocation

3 Investing Truths to Live By (Right Now and Always) (Kiplinger)

Disclaimer: This article is not intended to be investment advice. Consult a duly licensed professional for investment advice. The contents of this article are for educational purposes only and do not constitute financial, accounting, tax, or legal advice. Past performance is no guarantee of future results.