The last few days have been quit volatile on the stock market. Big drops, big gains, bigger drops, more rallies, and more slides. With all this volatility, some people are in a panic, ready to sell. However, panic selling rarely does you any good when it comes to a long-term investing strategy. Being prepared for a stock market drop isn't about have stop loss orders ready to trigger; rather, it's about being ready to seize the opportunities that come in your way.
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Bargain Hunting During Times Of Stock Market Decline
If you aren't maxing out your tax-advantaged retirement accounts, now might be a good time to add a little more. Over the long haul, the stock market has consistently gone up (of course, there's a first time for everything — including long-term stock market losses). This means that if you take the opportunity now to buy more for your retirement account, you have the chance to reap better tax-advantaged gains in the future. This is especially true if you happen to have a Roth account. Those bigger earnings could be tax-free when the time comes to withdraw.
Another way to bargain hunt during times of stock market decline is to look for good quality stocks with solid fundamentals. Dividend investing can be a great opportunity at this time. Many dividend stocks — especially dividend aristocrats — have a history of coming through tough times. These stocks are “on sale” during a market decline, and you can buy more shares for your dollar. This means that you have the chance to reap bigger gains on increases in stock prices, as well as owning more shares that pay dividends. If you want to boost your income portfolio, now might be the perfect opportunity.
Tax Planning During A Stock Market Drop
A down market isn't just great when it comes to bargain hunting. You can also use this as an opportunity to reduce your tax liability. As you know, you have to pay capital gains taxes on your earnings. The good news, though, is that you can offset your gains by losses. If you locked in some investment profits earlier this year, you can lock in some losses now to offset the income. You can use up to $3,000 in capital losses to offset capital gains each year. If your capital loss is more than $3,000, you can carry over the excess to another tax year, so that losses incurred this year can help offset capital gains in years to come.
You do have to be wary of the wash sale rule, though. If you buy the same security again within 30 days (before and after the sale), you will fall afoul of the IRS if you try to claim the loss. This prevents people from selling a stock at a loss and using it as an offset, and then turning around and buying the same (or a very similar) stock at a lower price to profit from later.
Bottom Line
One of the best things you can do for your finances is to order them so that you are prepared to take advantage of opportunities that come in your way. If you are properly prepared, either with capital to buy more stocks while they are on sale or a plan to sell at a loss to offset earlier gains, you can benefit from stock market declines.
Over the past few years I’ve not cared whether the market goes up or down. I’ve been fully invested at all times and have enjoyed the volatility.
During that time I’ve been using the same trading tools that the big boys do. Despite the mystique, it’s really very simple to protect your holdings and profit from the volatility.
The keys are to focus on quality stocks, foregt fear, greed and envy. You can do so very easily by selling calls on your positions. I stick to the same 50 or so stocks, cycling them in and out, while all the while milking them for their dividends and options premiums.
The downside? There will be times that you won’t get the full value of a sudden price appreciation of a stock. But I’ve been very happy to trade that off for the ability to sleep soundly at night even if the Dow is down 500 points.
Thank you for the excellent article Miranda. Successful investors must always be thinking ahead. Being prepared for opportunites in bear market markets is one of the best ways to increase long term returns. Unfortunately it is too hard for many people to do. My service, the Arbor Investment Planner, helps people with self-directed investment management. I use the principle having significant cash reserves to buy bargains in bear markets and help my subscribers implement their plan. I have written an article “Maintain a Stock buy List of Companies to Invest In” for anyone interested.
http://blog.arborinvestmentplanner.com/2011/07/maintain-a-stock-buy-list-of-companies-to-invest-in