(Sam Swenson, CFA, CPA)
As of the date of this writing, it looks like S&P 500 stocks have finally entered a bear market, or reached levels 20% below their previous highs. While this is unnerving for even the most stoic investor — and especially so if you’re in or entering retirement — there are many good reasons to leave your portfolio alone to the extent you can.
Let’s look at three of the best reasons to avoid selling stocks during a stock market downturn.
1. You’ll maintain your holding periods
Stocks held for longer than a year are eligible for long-term capital gains tax rates, which are significantly more favorable than their short-term counterparts. If you sell stocks after they’ve lost value, you’ll reset their holding periods when you reenter the market, meaning you’ll have to wait an additional year to again qualify for long-term treatment.
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By refusing to sell in the midst of a downturn, you’ll maintain your existing holding periods. This can benefit you in the event you’re able to sell at a gain when the market returns to its previous levels, and it will also bring you closer to qualified tax treatment on any dividends you may be eligible to receive. If you’re able to hold a stock, mutual fund, or other security for a specified period of time, you’ll also have the chance to pay lower taxes on any dividends received.
2. You’ll take advantage of dividend reinvestment
It’s interesting that most people will want to run from the market when it’s falling but will also run toward it as it becomes overvalued. While it’s clear stock market downturns aren’t good for the base of your portfolio, they do present valuable opportunities to buy in.
To that end, dividend reinvestment happens when dividends are paid and then automatically reinvested; The long-term opportunity is magnified if this happens after a market decline. If you receive a dividend after a market correction, your dividend will be reinvested at a lower price, and you’ll in turn purchase more shares than you would have otherwise.
This often happens “behind the scenes” if you’re not constantly monitoring your account and have dividends set to reinvest automatically. But it proves to be a valuable strategy in supercharging your account balances over time.
Below, you’ll find a graph of the S&P 500’s performance since 2010 with (total return price % change) and without (price % change) reinvesting dividends:
3. You’ll avoid acting on emotion
Any time you sell stocks in a panic, you’re acting based on short-term market movements while likely abandoning a long-term vision for your finances. This is not a wise investment strategy, as markets are inherently volatile and tend to fluctuate for a wide variety of (unpredictable) reasons.
A more sustainable course of action comes from thoughtfully building a financial plan — ideally in writing — and following it to the best of your ability. This often means assessing your goals and life circumstances, sectioning off an emergency fund, and developing an appropriate asset allocation. Having a plan in place ahead of a market downturn can really go a long way in keeping your emotions in check.
Revisit your financial plan
Let’s face it: no investor likes watching the market give up a year-plus worth of gains. It’s painful. But it’s something we’ll all need to get used to if we want to invest in financial markets and reap the long-term rewards.
Having a long-term plan and acting on it is truly the best path to growing your wealth over the long run. Getting the most out of your investments often comes down to doing a few basic things consistently, which include investing periodically, managing your taxes, reinvesting your dividends, and avoiding acting on raw emotion.
Should you commit to a long-term plan with an adequate emergency fund, you’ll feel less of an urge to sell when things get dicey.
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