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AS A TEENAGER, I started to invest by buying a boring old target-date retirement fund. But from there, I became an avid watcher of CNBC while studying finance in college. Indeed, my first financial love was technical analysis. Even today, when markets turn volatile, I’m as susceptible as the next investor to turning on financial cable TV to check out the supposed carnage.
Still, as time has worn on, my perspective has grown longer term and away from day-to-day market movements. In the college finance classes that I now teach, I always try to convey to my students the benefits of documenting their long-term financial goals. I encourage them—as well as others—to draw up an investment policy statement that details what their financial goals are and how they plan to reach them.
Yet I understand that many of my students have the same trading itch and market fascination that I had when I was in their seat. Do you feel the urge to “play the market” every so often—and especially right now, amid the whole coronavirus scare?
Let’s start by putting things in perspective. The typical year sees at least a few daily drops of 2% or more, while the average peak-to-trough decline for U.S. stocks during a calendar year is 13.8%, according to J.P. Morgan Asset Management’s Guide to the Markets. In other words, what we’ve experienced so far this year is entirely normal.
But we’ve all heard that before—and, depending on how you’re invested, it may not be all that comforting. We’ve seen a wide variation in the performance of different national stock markets over the past two years. While there have been plenty of recent headlines about all-time highs in the U.S. stock market, many international stock funds are down 15% to 20% since January 2018.
Itching to act? I’m not going to preach the extreme and say investors should avoid all short-term trading. Nobody will listen. But I do have two suggestions.
First, if you feel compelled to do some trading, try to confine it to a small portion of your portfolio. That way, if you get it wrong, the damage to your financial future will be limited.
Second, do your trading in a regular taxable account. This runs contrary to conventional wisdom, which says it’s best to confine any trading to a retirement account. The rationale behind conventional wisdom: If you trade in, say, an IRA, you avoid having to report all your investment sales to the taxman, plus you won’t have to pay taxes at ordinary income tax rates on any short-term capital gains.
Nonetheless, I still favor trading in a taxable account—because that way the government shares in the risks you take and you effectively lower the volatility of your returns. How so? If you have realized gains, you will owe taxes on those gains, which will reduce your profit. But if you have realized losses, it isn’t quite as bad, because you can offset those losses against any realized capital gains. What if you have a net investment loss for the year? You can use that loss to trim your taxes on up to $3,000 of other income.
Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles were Good as Gold, Keep On Keepin’ On and If Only. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.
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Nice article Mike. I like the twist that the government shares in the risk via taxes. One other thing I do – whenever I get the itch to buy the dip I remember that we are still contributing regularly to retirement accounts. So we are buying through the drop, accumulating more shares.
I use the dips to implement 25% of my planned Roth IRA conversions. This is just some minor tweaking but should have some long term rewards. I was “lucky” to have waited towards the end of December in 2018 and took advantage of that major decline but had an opposite experience at the end of 2019. Overall this is probably not a high risk/reward scenario.