When life hands you a lemon ... you can eat it but your face will scrunch up. Or you can make lemonade.
But sugar is not that great for you, so don't do that. Maybe you can drizzle it on fish or something. Regardless, when life hands you a lemon, you need to get creative.
This stock market has been a real lemon. If you fell in love with the highest value your portfolio has ever been, it is unrequited love. Rather than scrunch up your face at your investment statements as they come in, there are four things that you should be considering.
First, if you own underwater investments in taxable accounts, you shouldn't let those losses go to waste. Let's say you invested $10,000 in an S&P 500 fund that is now worth $8,000. If you just hold it until the market recovers, that loss disappears. A better strategy would be to swap into a similar, but not identical, investment such as a total stock market index. You obviously need to consider transaction costs, but if you do this that $2,000 loss can be used against this year's taxes (up to $3,000 of capital losses) or saved to be used against gains in the future. This is especially valuable if you plan on incorporating step two.
Rebalancing your portfolio is the second thing you want to do. Rather than make wholesale changes in your asset allocation, you want to move money back into your targets. Well-diversified portfolios should have set allocations between large stocks, small stocks, international stocks and bonds. Whenever a category gets out of whack, you should rebalance back to your targets. Again, you need to pay attention to tax and transaction costs. Virtually every investment class is cheaper than in January, but some have fallen more than others.
The third thing to consider, especially if you have a lump sum to invest, is to do so gradually. Since markets go up over two-thirds of the time, gradual investing may not pay off financially as much as dumping everything in, but it probably has a better psychological impact. When you consider gradual investing, use both date and price triggers.
For example, if you had $10,000 to invest, you can invest $2,000 every four weeks or every time the market falls by 3%. It is easy to set this up through a brokerage account by using a limit order with, for example, an S&P 500 exchange-traded fund (ETF). With a limit order, you put in a price at which you want to buy and if that price is hit, the order executes. In my example, you would invest $2,000 now and set four limit orders 3% below the current price and each other.
This works great if the markets are falling. You need to use date triggers to insure you get invested if the markets no longer fall. Every time a date trigger hits, make sure to cancel your lowest priced price market trigger. Use this strategy if the new money you are putting in the market is more than 20% of your overall market exposure.
