Bear markets can be unsettling for investors as they watch their portfolio balances fall along with the market. Christine Benz discusses productive things that investors can do during a bear market.
• What a bear market is
• Why your savings rate or drawdown rate matters more than ever
• How to rebalance during a bear market
• What a bear market means for retirees
• Why it can be good to buy stocks during a bear market
• Smart tax strategies in a bear market
Susan Dziubinski: Hi, I'm Susan Dziubinski from Morningstar. During a bear market, investors may be tempted to do one of two things—panic-sell or, conversely, tune out and ignore their portfolio entirely. Joining me to discuss some constructive steps investors can take instead is Christine Benz. Christine is Morningstar's director of personal finance and retirement planning.
Hi, Christine. Nice to see you today.
Christine Benz: Hi, Susan. Great to see you.
What a Bear Market Is
Dziubinski: So, let's start out—to make sure everybody is on the same page—let's talk about what exactly a bear market is.
Benz: A bear market can apply to any asset class, but in the case of stocks, we talk about a bear market being in place when stocks have dropped 20% below their high. So, the S&P 500 breached bear-market territory in June of 2022. The Nasdaq Index actually breached bear-market territory earlier this year.
Dziubinski: Today, you're here to talk a little bit about some productive steps that investors can take to actually improve their portfolios or their financial plans during a bear market. And on the top of your list is reviewing how much money you're actually putting into your portfolio or taking out of your portfolio. Talk about that one.
Benz: These are really the two big levers we have as investors. When we're in that contribution phase, if we're still working and contributing to our retirement plan accounts, the biggest determinant of our plan's success or failure will be our own savings rate. So, take a moment to review how much you're putting in. See if you can't bump up your contribution a little bit, because especially if you're early in your investment career, these down markets are your friend. They're the opportunity to put more money to work, to buy more shares for the same amount of money than when things were higher. So, they're really beneficial for you even though it might not feel like it at the time.
When it comes to retirement, if you're actively in drawdown mode, you want to look at that withdrawal rate, revisit it, make sure that it's reasonable. There's been reams of research done on this topic, but a lot of it points to the value of being at least somewhat flexible in your withdrawals if you possibly can. If you can take less in down markets in terms of your withdrawals, that will be beneficial for the health of your overall plan. And I know both of these things, both increasing contribution rates or potentially taking less if you're in drawdown mode, can be a heavy lift given that we're in this high inflationary environment. But play around with your budget, see if you might be able to tweak things a little bit there.
Dziubinski: Now, you say that the second productive step to take during a time like this is to rebalance. Why is that?
Benz: The basic idea is that as the market goes down, typically volatile assets, typically stocks, decline in value as a percentage of your portfolio. And the issue is that they can depart from whatever target you had. So, maybe your plan was to have a 70% or 75% stake in stocks on an ongoing basis. Well, you may find that you've drifted down significantly from that, given the losses in the equity market. That might not have happened quite as much as you might imagine, because bonds have gone down, too. But do a little bit of work, look at your portfolio's asset allocation, compare it to your target. If you don't have a target asset allocation, think about getting one, because the basic idea is that you want to have an appropriate mix of stocks and safer assets in your portfolio, and you want to rebalance back to those targets on a periodic basis.
It Can Be Good to Buy in a Bear Market
Dziubinski: Now another productive activity during a bear market can be bargain-hunting. So, how do you define bargain-hunting?
Benz: Well, the good news is, if you're doing a basic rebalancing strategy like I just talked about, you're already doing some bargain-hunting. You're buying things that have gone down. Presumably, their valuations are cheaper. So, you don't need to get a lot more complicated in terms of bargain-hunting than that. But if you are someone who likes to have a little bit more control over your investment holdings, you can look at your subasset allocations. So, one thing we've seen is that growth-oriented stocks and funds have gotten hit really hard in this market environment. They may have fallen below your targets for them. You may be able to find an opportunity to add to them. If you're an individual stock investor, you may be able to find bargains amid the wreckage of this market so far this year. And certainly, Morningstar.com has a lot of great tools for helping you identify stocks that are trading inexpensively relative to their future prospects. Our strategy for selecting stocks, our analysts' strategy, very much anchors on this idea of valuation being important. So, if they're recommending companies, they like them to be trading at a decent discount to fair value.
Tax-Loss Selling in a Bear Market
Dziubinski: And your last two productive bear-market ideas of things you can do have to do with taxes, and the first is tax-loss selling. Tell us about what that is and why it's beneficial.
Benz: Tax-loss selling involves your taxable account, so it wouldn't pertain to IRAs or 401(k)s. Within your taxable account, you're looking for holdings that are trading below what you paid for them. So, you're looking for a statistic or a data point called cost basis, and then you will compare that to the current price to determine whether you are potentially a candidate for tax-loss selling.
This can be an advantageous strategy because if you find tax losses in your portfolio—you sell a holding that is trading below what you paid for it—you can capture what's called a tax loss. That tax loss can be used to offset capital gains elsewhere in your portfolio. It can be used to offset up to $3,000 in ordinary income. And those tax losses can also be carried forward into future years. If you don't have any capital gains in your portfolio, you can carry it forward to potentially use it to offset gains when you do in future years. So, it's a super advantageous strategy, but again, it would only apply to taxable holdings. One thing I wanted to mention is that you cannot rebuy the same security within 30 days of having sold it—that you would essentially disallow the tax loss if you do that. So, you need to be careful. You can't buy the same security or one that the IRS considers substantially identical. So, do your homework there.
Roth IRA Conversions in a Bear Market
Dziubinski: And then, your final productive bear-market strategy involves converting traditional IRA assets to a Roth. What's the benefit of that, and why is it a good idea to do a conversion during a down market?
Benz: Sure. Roth assets have a lot of advantages. The two biggies are that you are able to take tax-free withdrawals in retirement. And then, for Roth IRAs, required minimum distributions don't apply. So, there are no rules about when the money has to come out in contrast with traditional IRAs, traditional 401(k)s, and Roth 401(k)s. So, those are the two big benefits.
The reason why it's advantageous to do a conversion when the market is down is that depresses your balance and that depresses the taxes that you will owe when you do the conversion. Because the hitch with conversions, as attractive as they seem, is that you will owe taxes on any appreciation in your account or any funds that you've put in on a pretax basis. So, there will be taxes due on conversions, but generally speaking, if your balance has depressed a little bit, that's a good time to think about doing a conversion. Get some tax help because it can be a little bit complicated to think through the implications. You may want to do a series of conversions over a period of years rather than one big conversion all in one year. So, definitely, get some tax advice before proceeding.
Dziubinski: Christine, thank you today for your time, for these five things that we can do to occupy our time and improve our portfolios during a bear market. We appreciate it.
Benz: Thank you so much, Susan.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.
Watch more: How to Invest During a Bear Market