Silver Linings of a Market Downturn
Originally published on October 2, 2022.
As I’m writing this email, we’re at, or near, this year’s lows. The underlying causes are still the same: The Federal Reserve is fighting inflation with higher interest rates, and markets are having a hard time adjusting. Trading algorithms are also kicking in, leading to a mass selloff across stocks, bonds, energy and real estate. When different investments all fall at the same time, it can be demoralizing.
Bear markets are a grind. Staying invested is a discipline that patient long-term investors have to develop, and it feels like trial by fire.
On the flip side, money invested in a bear market often has the highest rate of return after several years. Legendary value investor Shelby Davis said, “You make most of your money in a bear market; you just don’t realize it at the time.”
To illustrate the point, here’s an updated version of the S&P 500 chart:
Downturns in 2008, 2018, 2020, and 2022 are marked in red. Market recovery and growth, in blue, take their time. Between 2006 and market close this past Tuesday, patient investors in the S&P 500 saw their money grow by 192%. Source: Yahoo! Finance, retrieved September 27, 2022.
It’s a pretty compelling chart if you have a multi-year time horizon. But as much as I like the wealth-building power of stocks over time, I don’t know anyone who owns only stocks. We all live in the real world, where cash and very low risk investments are the bridge that get us safely from point to point in the present day. Cash can come from monthly income (wages, social security, etc.) and/or from savings you’ve previously set aside in bank accounts and/or investments.
For the cash you have set aside, there are actually some silver linings in this tumultuous market. For the “safety blanket” portion of your portfolio that you want to keep stable, consider these options:
FDIC-insured savings accounts now pay a decent amount; for example, Ally’s high-yield savings offering pays 2.10% (as of Sept 6, 2022) and Marcus is paying 2.15% (as of Sept 22, 2022). If your savings account is not earning that much, consider moving your cash to earn more with no risk.
U.S. Treasuries and FDIC-insured CD rates are way up. If you’re able to lock up cash for a short period of time in exchange for a higher rate, then these are great options. For example, a 12-mo CD from Morgan Stanley is currently paying 4.05% (Note that rate quotes change frequently these days.). We can purchase brokered CDs for you in your TD Ameritrade accounts. You can also check what is on offer at your local bank or credit union. Just respond directly to this email and we can chat about the details.
Inflation-linked Bonds (I Bonds) are a great option if you have a five year time horizon. If you buy before the end of October, you can still lock in a 9.62% interest rate for the next six months. After that, the interest on your bonds will adjust (probably lower) every six months to whatever the inflation rate is during the adjustment period. Remember you’re limited to $10,000 for each calendar year. The details on I Bonds can be very confusing, so make sure you go to TreasuryDirect.gov to learn more.
For your long-term investment portfolio, I am looking for ways to boost future returns and/or reduce taxes. Depending on the investment strategy that you and I have crafted together, these are some of the tactics we can deploy:
Tax loss harvesting may lower your tax bill in 2022 and possibly in future years. The Black Barn team has already started this process in taxable accounts, and you can expect to see more activity as we move toward the end of the tax year.
Roth conversions may reduce your future tax liability. This is a great move in a bear market IF you expect that your tax bracket today is lower than what it might be in the future. A Roth IRA is also a great estate planning strategy as it gives you potential to leave a tax-free asset to future beneficiaries. We’ll be in touch if this applies to your situation.
If you have a long term outlook and extra cash/income to invest, then adding to stocks while others are panicking is a tried and true way to build real wealth. It’s not for everyone, but remember that the expectation is that the stock market doubles every 7-10 yrs on average.