The S&P 500 Index dropped 3% on Monday! While this might seem alarming, the market has experienced similar single-day declines 82 times since 2000, averaging about 2.3 times a year. Such corrections are not unusual. This decline might feel more surprising because it's the first in two years since September 13, 2022.
You might be wondering, "Does this affect me?" and "Should I be concerned?" Here’s a simple guide:
- High Panic: You are heavily invested in the Nikkei and have a leveraged carry trade in the Yen. You are also retired and rely entirely on your investments for living expenses.
- Low Panic: You are not diversified in your investments, have a strong tilt towards Japanese banks, and are at or close to retirement.
- No Panic: You are diversified, with a solid financial plan in place. You might be nearing, or beginning retirement, but are just as likely in the early stages of a long-term investing plan.
While we can't disclose information about individual clients, we can confidently say that none of our clients fall into the first two categories.
The recent trading in global equities is a reminder of what is often overlooked during a year of steady market gains. Despite the financial press's narratives, markets do experience downturns as well as upswings. In fact, market drawdowns exceeding 10% are more common than many investors realize. Since 1979, the average intra-year decline has been 14%.
As long-term investors, we welcome market drawdowns. Why? Because they offer several opportunities for astute investors. We can upgrade the quality of our holdings, dollar-cost average to enhance long-term returns, and generate tax efficiencies that mitigate capital gains taxes, allowing us to rebalance our portfolios more effectively.
We relish the chance to improve our portfolios during bear markets. In a downturn, correlation often increases. This means that when investors panic, they do not distinguish between high-quality businesses with enduring competitive advantages and weaker, struggling companies. Panicked sellers simply seek cash, causing everything to drop similarly. We capitalize on these periods to purchase high-quality names at discounted prices—a rare opportunity not to be missed. In rational markets, these companies typically trade at a premium.
Bear markets also present an opportunity to deploy cash. For employees, this is an excellent time to maximize 401(k) contributions or make after-tax contributions to IRAs or Roth IRAs. Down markets are usually prime times to advance 529 contributions for children or grandchildren. The IRS allows multiple years of contributions at once, and given the long-time horizon for beneficiaries, making larger contributions in a down market should lead to better returns and more funds for educational needs.
Additionally, down markets offer tax mitigation opportunities. The growth of ETFs exposed to similar market trends, despite differences in holdings, has simplified tax-loss harvesting. Investors can sell investments that have declined from their entry point, bank those losses for future gains, and re-enter similarly exposed securities with ease. These “tax losses” can be used to rebalance portfolios without incurring taxes on the sale of appreciated investments. The resulting tax savings generate extra capital in clients’ accounts, which compounds over time. Even modest tax savings can significantly impact your account value when compounded over many years.
When “experts” and other advisors advise against checking your account or doing anything during a down market, they are only partially correct. What they really mean is “don’t panic sell” or attempt to time the market by going to cash. But the full advice should be, “take advantage of the opportunities to upgrade your portfolio, increase contributions, and capitalize on tax mitigation strategies.” By doing so, you can turn down markets to your advantage and set yourself up for greater long-term success.
So, put away your survival kits, unload your guns and take your helmets off, it isn’t the end of the world! And, as a wise mentor used to say, “The end of the world isn’t investable because it will only happen once.”