A Playbook for When the Stock and Bond Markets Are Down

There’s a simple measure I use to determine how volatile the stock market is: the number of days the S&P 500 index has closed up or down by at least 1% during the current calendar year. 

Through yesterday’s close, there have already been 46 trading days this year with a daily gain or loss of at least 1% in the S&P 500. This compares to a calendar-year average of 53 days for the period of 2011 through 2021.

Looking at just 2% days is more telling. So far, there have been 15 days in 2022 when the S&P 500 has closed up or down by at least 2%. The last 11 full calendar years have averaged just 13 days with a change of at least 2%. Already, 2022 has the fourth-highest number of 2% days since 2011. The only calendar years with more 2% daily changes are 2011 (35), 2018 (16) and 2020 (44). 

Volatility refers to the fluctuation in returns, not the direction. But the overall direction of stocks this year has been down. The S&P 500 is near the bottom of what counts as a correction. A further decline below 3,855 (down 20% from its previous record high) would put the index into bear market territory. Already, the Nasdaq composite and the Russell 2000 index are well into bear market territory (down 30% and 29%, respectively).

Given this, I’m going dust off the down market playbook I shared back in January. A few additions are included in this updated list. The ultrashort version is the timeless advice given in The Hitchhiker’s Guide to the Galaxy: “Don’t panic.”

What Can Investors Do Now?

Be clear about your investing goals. If you’re an investor, there is something you hope to do with the money you’re investing. It could be funding retirement, buying a house, leaving an inheritance or amassing a large amount of wealth. Whatever your goals are, there are estimated target dollar amounts, expected times for when they will be reached and durations over which you will spend on the goals. These things should govern your investment decisions—not what the market is doing on a short-term basis. Our PRISM-Wealth Building Process is based on this concept.

Stay the course. If you’ve set up your portfolio to reach your long-term goals, then continue to stick to your strategy. The risk of making a mistake by acting on what you think might happen is greater than the risk of what will actually happen.

Check your allocations. Down markets can cause your portfolio allocations to stray far off target. If they have, adjust your portfolio back to your targeted allocation. You can do this either through rebalancing, targeting certain asset classes/asset class categories for receiving new savings contributions or as sources to fund withdrawals, or a combination of the two.

Be an investor, not a speculator. Being an investor means thinking like a business owner. If there is a reasonable expectation that the prospects of the companies you hold shares of have not changed, then don’t sell just because the price has declined. The exceptions to this statement would be the specific and prior use of price in your strategy, meaning technical analysis and predefined stops.

Harvest losses for tax purposes. While we don’t think you should sell a stock if its long-term fundamental outlook hasn’t changed, there can be an opportunity to “sin a little” for tax purposes. This would involve realizing a capital loss by selling a stock or other investment [mutual fund, exchange-traded fund (ETF), etc.]. In doing so, be sure to wait more than 30 days before repurchasing it or buying a substantially identical investment to avoid violating the wash-sale rule.

Go bargain hunting. A lack of optimism among other investors creates an opportunity for you to open your wallet. If the business is sound and you don’t have any reason to believe that its longer-term prospects have changed, you may be able to pick up some bargains.

An alternative suggested by Lauren Templeton of Lauren Templeton Capital Management is to place limit orders to buy stocks at significant discounts to their intrinsic value (based on discounted cash flow or valuation multiples). If the price falls to your target, the order is executed. As a safeguard, she advises looking for companies with little to no debt. She said her great uncle, Sir John Templeton, used this strategy throughout his career.

Consider doing a Roth IRA conversion while prices are down. The IRS only cares about the dollar amount converted from a traditional IRA, a 401(k) or similar type of tax-deferred account to a Roth IRA, not the number of shares converted. So, when prices are down—as they are now—you can move more shares over to a Roth IRA for the same tax impact.

Accelerate the timing of IRA contributions. While I’m a big proponent of dollar-cost averaging, downturns are an opportune time to be a bit tactical. Downturns give you the opportunity to buy more shares for the same dollar amounts you would have contributed anyway. By accelerating, you’re simply shifting the timing of those contributions to take advantage of the cheaper prices.

If retired, reduce your spending. Retirees can boost the odds of not outliving their savings by reducing spending to the extent possible during down markets. Doing so reduces the amount you need to withdraw from your portfolio. Floors (minimum spending amounts) and ceilings (maximum spending amounts) help to make fluctuations in spending more tolerable.

Ladder bonds and CDs. If it’s rising interest rates that have you concerned, consider diversifying the duration of your cash and bond allocations. Buying bonds, defined maturity bond funds and certificates of deposit (CDs) of varying maturities allows you to pivot to future rate environments without relying on potentially incorrect forecasts. As your shorter-term investments mature, you’ll be able to reinvest the proceeds at the then-prevailing yields while still having exposure to the current longer-term rates. Though the monetary policy is being tightened now, it will likely be loosened whenever the next recession occurs. (The Treasury’s Series I bonds are another option for those worried about interest rates. We discuss them in next month’s AAII Journal.)

Turn off the TV, stop visiting financial news websites and just breathe. If your investment horizon is not one week, one month or one year, then there is no advantage to watching the market on a minute-by-minute or day-by-day basis. Paying constant attention to the market can cause you to become more nervous. As long as your cash flow needs are covered—salary if working; pension, Social Security benefits, portfolio income and/or two to four years of cash savings if retired—there is no need to react to the market’s short-term moves. Rather, find something more calming to engage in. Even spending a few minutes simply focused on your breathing can help.