What To Do During a Stock Market Downturn — Oblivious Investor

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And now on to today’s topic: what to do during a stock market downturn.

As of the close of trading on Friday (4/4), the US stock market (as represented by Vanguard Total Stock Market ETF) was down 8.14% in the last 5 days and down 14.1% year-to-date.

The Stock Market Doesn’t Care About Your Politics

Because this recent decline was kicked off by the new Trump tariffs and responding actions by other countries, many people are responding in ways that are informed by their political views. (You can see it happening in real time at the Bogleheads forum, for instance. And if it’s happening there — a place that’s known for being nonpolitical and populated with buy-and-hold investors — you can bet lots of other people are making similar changes.)

But the stock market didn’t suddenly become predictable, just because you either really like or really don’t like the tariffs. That is, fundamentally, not how this whole stock market thing works.

The stock market responds to available information. And it does so pretty darned quickly. Do you know something that the market collectively does not know? Do you somehow know whether Trump will keep these tariffs as-is, raise them, or lower them (and by how much and when)? And do you know how other world leaders will respond? Frankly I doubt even Trump’s chief of staff knows the answer to those questions. And if you don’t know those answers, you shouldn’t be making stock market predictions based on the tariffs.

Check Your Risk Tolerance

Now, when things are scary, is the time to evaluate your risk tolerance.

If you’re losing sleep or feeling ill over what is, so far, a decline of less than 15%, the blunt truth is that your asset allocation was way too risky for you.

Just in my own investment history, we’ve seen two declines of roughly 50% (2000-2002 and 2007-2009). You have to be prepared for that sort of experience, with respect to any money that you have allocated to the stock market.

And if you’re thinking, “this time is different!” yes, you’re right. This time is always different. That’s the key thing to understand.

In early 2020, we saw an extremely quick decline, coupled with a pandemic. That was certainly a new and scary experience.

In 2008-2009, we saw a quick and large decline, coupled with major financial institutions collapsing and a non-trivial possibility of the whole thing becoming system-wide if too many large institutions failed. That was a new and scary experience.

In 2000-2002, we saw a large decline that just kept on going and was coupled with things like major accounting fraud scandals. Could we trust that the market wasn’t just a scam, rigged against the little guy? It was a new and scary experience.

That’s how these things go. A significant market decline doesn’t happen out of thin air. Such declines are generally accompanied by some scary real-world event.

If you’re going to invest in the stock market, you have to be prepared to see large declines from time to time, coupled with something scary going on.

Rebalance (or Not)

In addition to evaluating your risk tolerance, now is a good time to rebalance — if your plan calls for such.

Over an extended period of time, the general effect of rebalancing is that it reduces returns and reduces risk, relative to a portfolio that is never rebalanced. That’s because, more often than not, it’s the stock part of the portfolio that has risen above the intended percentage, and so rebalancing most of the time means selling stocks and buying bonds.

Right now, it would be the opposite. The point of rebalancing today would be to increase expected returns.

Rebalancing isn’t necessarily mandatory. Depending on your circumstances, it could be reasonable to have an investment policy statement that calls for rebalancing out of stocks when the stock allocation gets too high but does not call for rebalancing into stocks when the stock allocation is below the targeted level.

Tax-Loss Harvest

If you have investments in a taxable account, now may be an opportunity to tax-loss harvest.

As always, be careful of the wash sale rules. (And as always, I do not have the answer as to whether two funds count as substantially identical or not, because there’s no IRS guidance on the matter.)

Reevaluate Your Plans

Market declines are also a good time to reevaluate your plans. Does this change mean we need to cut spending? Does it mean we should be pushing back our planned retirement date?

Roth Conversions

Finally, Roth conversions, if using money from a taxable account (rather than from the tax-deferred account itself) to pay the tax, become a slightly better deal during a market downturn, because you’re converting a greater number of shares per dollar of taxes paid. But that wording probably makes it sound like a bigger deal than it is. It’s not that you’re paying a lower tax rate on the conversion. You’re just getting slightly more “oomph” out of the “use taxable dollars to pay the tax on the conversion” concept.