Levelheaded Investors Do This

Five things to do in a market correction or bear market.

Rational, calm, and sensible investors have an approach that runs contrary to market behavior. I like to think one of the things I have learned is to like bear markets and corrections. Here are five things I do when the market drops 10% or 50%.

Number One: Ask “Why?”

Look at the past to consider the future and your possible response.

It is not unwise to consider the cause or causes of the downturn. However, many of them are fearful overreactions to short-term news. Some examples include the Federal Reserve acted, the Fed did not act, a new president was elected, a virus is making many people sick, ships cannot unload their cargo, or it looks like the Russian bear is on the prowl. Then I think back on past bear markets and corrections and decide this is just another fearful reaction to the unknown. Guess what? All of the future regarding investments is basically unknown. So, I don’t rush to sell any investments.

Number Two: Look at the Ex-Dividend Dates

Don’t run away from your dividend income.

Companies, ETFs, and mutual funds that have announced dividends will pay them. I don’t sell very many investments before the next ex-dividend date. Most months we have dividends arriving every week, even during downturns. In reality, that has effectively increased the yield on the investment. If I sell the investment, can I find a better yield on a similar quality investment? If not, I don’t sell.

Number Three: Buy More

Down markets are buy markets if you have cash available.

Dividends keep coming, but I turned off automatic dividend reinvestment. As a result, every month new dollars arrive in the cash portion (SPAXX – Fidelity Government Money Market Fund) of our accounts. If yesterday I could buy shares of one of my core investments for $100 per share, and today I can buy the same shares for $95 per share. I buy more shares. However, I don’t buy all of them at one time. There is no rush. Rather, if I have $1,000 to invest, I might buy 5 shares today and 5 more shares a couple of days from now.

Number Four: Do a ROTH Conversion

Do a ROTH conversion after you evaluate your income taxes.

A Roth IRA conversion is a conscious decision to transfer retirement funds from a traditional IRA or 401 (k) into a Roth account. This is a taxable event. If I own shares of an investment I like and plan to hold for at least another five years, a bear market often drives the price of that investment down with the other investments that are falling. Perhaps the shares in my traditional IRA were worth $10,000 a month ago, and now they are worth $8,000 if I were to sell them. I can move those shares from my traditional IRA to my ROTH and pay taxes on the $8,000 instead of the $10,000. This has the potential to give me more tax-free dividend income along with capital appreciation. I have done this every year for the past five years.

One word of caution: If you don’t understand income taxes and don’t know your tax bracket for your filing status, don’t do a conversion. Have someone help you with the math.

Number Five: Remember Diversification

Remember and examine your diversification.

Sometimes investors buy multiple mutual funds or ETFs that have similar holdings. For example, there are hundreds of funds that hold Apple, Microsoft, Amazon, Google, Facebook, and Tesla in their top ten investments. If you own multiple funds, and they are all going down faster than the overall market, it might be time to rethink your strategy. My approach has similar exposure. There are top ten investments in our portfolio. If all of them are in the same sector, perhaps I need to rethink my long-term strategy.

What You Should Not Do

What a wise investor does not do.

It should be obvious that I would counsel you against being fearful, worried, or reactionary. Make informed decisions. Don’t sell with the herd unless you bought a bunch of speculative investments. Of course, if you did that, you probably don’t care if you lose your shirt. Just be aware that the bear could eat up your retirement if you are rash and ridiculous in your investment approach. Finally, ask for help. Seek advice from a mature investor. If your financial advisor tells you to be patient and calm, then follow their advice. Of course, make certain they are a fiduciary. Don’t align yourself with a trader.