How to Prepare for Market VolatilitySubmitted by Insignia Financial Company on February 26th, 2020
How to Prepare for Market Volatility
By Matt Lenhardt, Financial Planner
Stock market volatility is inevitable, and if you have been paying attention to the trade wars, Coronavirus (COVID-19) outbreak, or the 2020 presidential election, you might be thinking about preparing for it. Volatility can lead investors to make rash decisions based on emotions, rather than logic. It’s important to have a plan to deal with market volatility before it comes, this way, investors can protect themselves from emotional decisions that could negatively affect their financial plans. This article will cover a few tips for investors on how to handle volatile markets.
Ignore the Media
How many times have you seen an article about the Dow Jones Industrial Average dropping hundreds of points in one day? If you haven’t, type “Dow Plunges” into Google search and see what results come up. You will see thousands of articles about daily market volatility that could make you think the sky is falling. Many self-proclaimed experts will try to convince you that they know exactly what will happen and when. The truth is media companies sensationalize market conditions to generate clicks and views. There is no way to know exactly what will happen in the market, and though these people might make some accurate predictions, they will not be right every time. The sooner you can block out the media’s sensationalized coverage of the market, the sooner you can start making your own informed, logical decisions about investing during times of volatility.
Diversify Your Assets
The most important step you can take to help mitigate catastrophic loss is to diversify your portfolio. Some younger investors may be more heavily exposed to equity investments (stocks) while individuals closer to retirement may own more bonds than stocks. The way an investor should diversify their portfolio will vary based on their age and tolerance for risk. Every person has different goals and their portfolios should be diversified accordingly. See a financial advisor for more advice on how to properly diversify your portfolio based on your unique needs and goals. Diversification does not guarantee a profit nor avoid a loss in a declining market.
Volatile markets where assets are decreasing in value offer unique opportunities for investors. A market decline can be a great time to pick up stocks when they are potentially under-valued. Dollar-cost-averaging is an investment strategy where individuals purchase a set dollar amount of an investment across a period of time. Dollar-cost-averaging may help investors to purchase assets at a lower price, over time as opposed to a one-time purchase. A lower cost should help diminish the impact of volatility.
A down market is also a good time for tax loss harvesting, which is a strategy for investors to sell off assets that have moved to a loss position while at the same time replacing them by purchasing similar, but not identical, securities. When these losses are realized, they can be used to offset capital gains that have been incurred. If there are more losses than gains you may offset up to $3,000 of ordinary income. Additionally, losses in excess of gains and $3,000 of ordinary income may be carried forward to subsequent tax years. Periodic investment plans do not assure a profit or protect against a loss in declining markets. Such plans involve continuous investment in securities regardless of fluctuating price levels. Investors should consider their financial ability to continue purchases.
A third opportunity investors have when the market is down is converting their traditional IRAs to Roth IRAs. The full value, principal and gains, of an individual’s traditional IRA will be taxable as income when it is withdrawn from the account. A Roth IRA’s gains and principal value are exempt from taxation as long as the IRS rules are followed. Investors can pay the taxes on their traditional IRAs when the market is down, and a smaller account will result in a smaller tax bill. This will allow the investor to pay the taxes and add the funds to his or her Roth IRA. From that point forward the account will not be taxable. Please keep in mind that current year tax rates, future rates and the tax impact of the conversion in the current year should be examined before making the decision to convert.
The market will experience volatility and at some point, assets may depreciate in value. It is important to remember that even though the media may try to convince you, it is not the end of the world. Investors need to take a step back to make sure emotions are not controlling their decision making when market volatility is high. There are many opportunities in a down market as long as investors don’t lose sight of their long-term goals.