Rough market environments like the current one remind me of the old quote from value-investing legend Shelby Cullom Davis: "You make most of your money during a bear market; you just don't know it at the time."
Easy for him to say. Yes, great value investors like Davis make their money by buying when other investors are panicking. But there's always someone on the other side of those trades. Morningstar's investor-return data, which aim to reflect investors' actual gains and losses, show that many investors mistime their purchases and sales. Before stocks began to recover in early 2009, for example, investors were flocking to bond funds, and they kept right on buying them through much of stocks' recovery. Bonds weren't a terrible investment subsequently, but they sure did underperform stocks.
Many investors have heard that they should do nothing with their portfolios during bear markets, and sitting still is certainly better than selling out of stocks altogether, or making shifts based on fear rather than good investment sense. But doing nothing may not be psychologically appealing. Moreover, there are constructive actions investors can take to improve their portfolios and their total financial plans during periods of market turbulence.
Cut Dead Stocks for Share Loss Relief
One way to make a save during weak markets is to reap a tax loss by selling depreciated securities from your taxable account. You'll be able to use those losses to offset capital gains on your 2015/16 tax return, and if your gains exceed your losses, you can use them to offset income.
Of course, the very securities in which you have the biggest losses may be poised to deliver the biggest gains when the market recovers, so you need to be careful that your tax-loss selling doesn't choke off your portfolio's future return potential. You can't sell something and rebuy it right away; doing so will effectively disallow the tax loss.
But you can swap a losing security for another that helps you maintain similar economic exposure. You may even be able to give your holdings an upgrade in the process, swapping a fund with a Morningstar Analyst Rating of Neutral for one with a Gold Rating, for example, or trading in a higher-cost fund with one with a rock-bottom expense ratio.
Even if your taxable portfolio doesn't feature a lot of good tax-loss candidates, you can use the sell-off as an opportunity to give your taxable account a tax-efficient makeover. If one or more of your holdings has been kicking off a lot of taxable capital gains distributions and you'd like to swap into a more tax-efficient index fund or exchange-traded fund, declining market values mean that you'll owe less in capital gains taxes when you make the switch.
Make ISA Contributions
Buying more stocks when the market is down can be psychologically difficult. But investors who haven't yet contributed to an ISA for 2015/6 have less than two months to do so. April 5, 2016 is the end of the 2015/16 tax year, and your £15,240 ISA allowance has to be utilised by then or you lose it. Procrastinators got lucky this time: The fact that stocks have fallen in the past year makes now a better time to contribute than last year.
See if Changes to Your Asset allocation are in Order
Before you make any changes to your portfolio, either adding to your equity holdings or subtracting from them, check your asset allocation relative to your target. With the FTSE 100 down 18% in the past year and some equity categories down much more than that, many investors may find that their equity holdings need topping up.
But investors getting close to retirement may find that they have too much of their portfolio in stocks given their life stage. For them, derisking may actually be in order, even if they've been exhorted to sit tight amid the volatility.
This article originally appeared on Morningstar.com. It has been edited for a UK investor audience.
