During market turbulence, it seems there are two competing narratives in the financial press and investment community. On the one hand, market timers advocate taking action to try to beat the market — making significant changes to allocations and investments in response to market conditions. We believe the evidence to be extremely strong that market timing efforts ultimately result in unsatisfactory results over long periods of time. The competing narratives seem to advocate some form of “staying the course” — that is, not to panic during downturns or euphoric during upturns, but rather stick to a long-term asset allocation.
But what does it mean exactly to “stay the course”? Investors sometimes misinterpret this to mean doing absolutely nothing. On the contrary, a turbulent market means that the disciplined long-term investor should consider taking action, but of a very different kind vs. the market timer. During a down market, a number of steps and opportunities should be considered, for example:
- Tax management, including tax loss harvesting and the rotation of investments’ asset location
- Reversals of Roth IRA conversions that qualify for a recharacterization
- Rebalancing (whether through new investments or by trading the existing portfolio) toward the long-term target allocation
- Estate planning or gifting strategies that take advantage of lower valuations
- Contributions to tax advantaged vehicles (e.g. IRAs and 529s)
- Mortgage refinances, if lower interest rates accompany the down market
- Diversification away from single stock positions, to the extent that embedded gains have been a barrier
These steps are more likely to add value, vs. trying to chase the market. And keep in mind that being in a position to take advantage of these steps requires preparation in advance, during an up market. For example, a portfolio should be well-diversified and should reflect an investor’s risk tolerance. As an extreme example, an investor that faces a severe recession holding only one stock faces the very real risk of his or her entire wealth going to zero. This particular investor is likely to be unable to “stay the course.” Conversely, an investor with a portfolio of broad asset class or index funds diversified across thousands of stocks and bonds is more likely to be able to ride out the storm, and divert his or her attention to some of the strategies discussed above.