Mark Twain famously quipped that "October ... is one of the peculiarly dangerous months to speculate in stocks, the others are July, January, September, April, November, May, March, June, December, August, and February." Boy was he right about October. The S&P 500 -- a broad measure of the US stock market -- was down 6.85% for the month. The Dow Jones Industrial Average dropped 831 points on Oct. 10, the third-largest one-day drop in history. Before you could catch your breath, the gains for the year were wiped out.
It was a scary month for investors, but a stock market drop doesn't mean it's time to panic. Instead, it's an opportunity! Shake off the holiday blues and make some lemonade from these lemons. Here are three financial planning opportunities for when the stock market plummets into a correction:
1. Buy more!
'Tis the season for holiday shopping and stocks are officially on sale. The S&P 500 price-to-earnings ratio, a broad measure of how expensive or cheap the stock market is, dropped to 21.33 compared to 24.85, a year prior. A lower P/E generally means stock prices are more favorable.
Want something more exotic for Christmas? Try investing foreign stocks. These have been on sale for a while now, generally due to the trade and tariff disputes going on. For short-term speculators, buying on dips can be like catching a falling knife -- you might get hurt -- but for long-term investors who believe in buying great companies at discounted prices, now could be a good time to go shopping in the market.
2. Tax-loss harvesting.
A lone consolation for those with stock market losses is something called tax-loss harvesting. Tax-loss harvesting is selling your stock that is down for the year and taking the loss.
Losses are used to offset gains in other parts of the portfolio, an extremely important strategy for mutual fund owners this year because some funds are expected to pay capital gain distributions. A capital gain distribution is when a mutual fund might have sold some stocks for a gain earlier in the year and that gain is then distributed to the mutual fund owners in December. It is then taxable to you as either short-term or long-term gain, depending on how long the position was held. Short-term gain is taxable as ordinary income, and long-term gain is generally taxed at a lower rate.
Either way, the last thing you want is a taxable capital gain distribution on a position that is down or at a loss! That is like rubbing salt on the wound. Use this market downturn to cull any positions that you no longer like and book the loss to offset potential capital gain distributions. You'll want to be careful of the wash sale rule, however, as breaking this rule will negate the loss.
3. Gift stocks to kids
Gifting stock to kids is a neat way to pique their interest in investing and help improve their financial literacy. The one caveat with gifting stock to your children is that they inherit your cost basis.
In tax lingo, this is called carryover basis, and it is the price you paid for the stock, which becomes your child's cost basis. This is important if you purchased the stock a long time ago, as it could mean the carryover basis the kids are inheriting can trigger a large tax bite if and when they sell.
For example, if you bought Stock A for $15 a share and now it trades at $30 per share, your kids have a basis of $15 per share upon your gifting it to them and a potential taxable gain of $15 per share ($30 minus $15). But if the price of Stock A dips to $20 per share, then your child has a lower potential taxable gain ($20 minus $15, or $5 per share).
A dip in the stock market can make gifting stock to your children now more advantageous due to the lower potential tax for them if they decide to sell. Obviously, we may want our children never to sell stocks so they can reap the long-term gains of the market, but let's face it, older kids, in college for instance, have all sorts of bills and may need the money now rather than later. Also, if you are older, you may want to wait, as your child will inherit your stock at a stepped-up basis. This means your child inherits the basis on the date of your death, which may be more advantageous than inheriting now.
If you've been an investor long enough, you know the downs are temporary and the ups are permanent. The Dow Jones Industrial Average hit a low of 6,443 on March 6, 2009, and now it's at 24,704! That is an impressive run. But it wasn't an easy run, as this year can attest to. At least now, armed with these three financial planning ideas, you have a head start if and when the next dip does occur. As Mark Twain also said, "The secret to getting ahead is getting started."