Making Portfolio Changes During Challenging Market Environments
One of the best-known investment management mantras during difficult times is to “stay the course,” but what does that really mean for equity investors in the real world?
Though individual circumstances always vary, conventional wisdom dictates that your best bet during a stock market downturn is to leave your stock portfolio alone (don’t sell), and give the investments adequate recovery time before selling, which can take weeks, months or years. However, not all investors have the luxury of time, so what is the best “Plan B” if holding indefinitely isn’t an option in the short run? Let’s expand on these concepts.
The case for staying the course
First, there is a reason “staying the course” is widely accepted as the optimal investor response to a stock market downturn. It comes down to data. We have about eight decades of historical stock market returns – since the Great Depression in the 1930s – to inform us. That data overwhelmingly indicates that during a market downturn, regardless of duration, leaving a stock portfolio alone and refraining from selling stock during the down period yields superior results in two respects:
1. The portfolio recovers more quickly.
2. In percentage terms, the recovery is larger than if an investor had sold stocks when the market was down (thereby realizing a loss) and then bought stocks back at some point in the future when the market had sufficiently recovered.
What if staying the course isn’t an option?
There are a few scenarios in which an investor seemingly must sell stock when markets are down because they have no other choice. This may be due to immediate cash needs or required minimum distributions (RMDs) from a retirement plan or IRA. What is an investor to do in these two circumstances?
Let’s begin with an immediate cash need. Consider the following alternatives:
1. Consider using other sources of cash, such as checking accounts, savings accounts, money market accounts, or other cash equivalents if they are available. You can plan to replenish these accounts in the longer-term by selling stock when the stock market has sufficiently recovered.
2. Determine if the immediate cash need has any degree of flexibility. Can it be reduced or postponed in the short-term? Even fixed expenses such as mortgages, debt payments, property taxes, income taxes, and other ironclad obligations can sometimes be temporarily suspended or deferred during extremely challenging times. Contact your financial institution/lender, local tax authority, or income tax preparer before making any changes to your payment schedule. Never assume that skipping a payment is permissible.
3. Consider using a line of credit or other lending facility in the short run. Depending on the size of the cash need and length of time before a sufficient stock market recovery occurs, the interest cost on the short-term use of a line of credit can be dramatically lower than the dollars lost by taking a significant stock loss in order to generate cash. If you do not have a line of credit or other lending facility currently in place, contact your private banker to explore this opportunity.
As for required minimum distributions (RMDs) from a retirement plan or IRA, consider the following attractive options:
1. Determine if your retirement plan or IRA is eligible for RMD suspension in 2020. Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act enacted in late March 2020, RMDs on IRAs, Roth IRAs, Inherited IRAs, 401(k) plans, and many other retirement accounts are waived for calendar year 2020. However, a notable exception to this RMD waiver is defined benefit plans. Confirm whether you can skip your RMD this year by consulting with your wealth advisor or tax preparer based on the type of IRA and/or retirement plan(s) that you hold.
2. If the CARES Act does not apply to your retirement plan or IRA in 2020, or in future years when RMDs are required again, request that your financial institution make an in-kind distribution of securities equal to your RMD amount from your retirement plan or IRA to another (non-retirement) investment account to satisfy the RMD rule. By distributing securities in share form rather than selling to cash and then distributing the proceeds, you can avoid realizing a loss until the investments have recovered in value.
While “staying the course” is often the superior course of action, individual circumstances and the ability to do so can certainly vary. Always consult with your wealth advisor first to determine what is best for your unique situation.
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