A bear market is generally defined by major indexes (particularly the S&P 500) declining by more than 20% from recent highs, and since the start of 2022, that's what we've experienced. It's been, to put it lightly, a rough year for the stock market.
Nobody likes seeing their portfolio's value drop, and it could be tempting to sell stocks as prices are falling to avoid further losses, but that's usually the wrong move. Here's why.
Image source: Getty Images.
Don't forget about Uncle Sam
Before selling any stocks -- especially for profit -- you need to consider the potential tax consequences. How much tax you owe on stock profits (called capital gains) depends on how long you've held the stock. If you've held a stock for less than a year and sell it, your profits will be taxed at your regular income tax rate.
You'll get a more favorable capital gains rate if you've held the stock for a year or more. Depending on your income, you'll either owe 0%, 15%, or 20%:
| Tax Filing Status | 0% rate | 15% rate | 20% rate |
|---|---|---|---|
| Single | $40,400 or less | $40,401 to $445,850 | Over $445,850 |
| Married filing jointly | $80,800 or less | $80,801 to $501,600 | Over $501,600 |
| Married filing separately | $40,400 or less | $40,401 to $250,800 | Over $250,800 |
| Head of household | $54,100 or less | $54,101 to $473,750 | Over $473,750 |
Data source: IRS.
Most people will fall into the 15% capital gains tax rate, meaning it'll cost $150 per $1,000 in capital gains made. Since your regular income tax rate is higher than your capital gains rate, it could be even more expensive if you recently bought the stocks.
Think about the future
In addition to the potential tax bill you could face by panic-selling, you should consider the future gains you could miss out on. As a long-term investor, your goal should be to invest consistently and increase your position in stocks over time. Any shares you sell prematurely are those you don't give a chance for future growth.
As an example, let's take a look at McDonald's (MCD 1.25%), American Express (AXP 1.26%), and Lowe's (LOW 1.45%), as well as the S&P 500 (^GSPC 0.11%). These all experienced major drops in the early 2020 bear market caused by the COVID-19 pandemic. Yet, here's how they have performed since then:
| Company | Feb. 2020 Peak Price | March 2020 Bottom Price | Current Price |
|---|---|---|---|
| McDonald's | $217 | $149 | $275 |
| American Express | $135 | $75 | $155 |
| Lowe's | $125 | $67 | $215 |
| S&P 500 | $3,380 | $2,305 | $4,003 |
Data source: Google Finance. Price rounded to the nearest dollar.
By no means is it guaranteed that all stocks will bounce back, but if you're investing in great companies, you should trust their long-term potential. History has shown that blue-chip companies and major indexes tend to weather bad economic storms and produce good long-term results. You don't want to add insult to injury by costing yourself in the present and future.
SNPINDEX: ^GSPC
Key Data Points
Aside from the potential value missed in a stock price increase, prematurely selling your shares can cause you to miss out on dividend payments. McDonald's, for example, has paid out $13.05 per share in dividends since the beginning of the early 2020 bear market. Had you sold 100 shares, you would've missed out on $1,305 over that span. Dividends reward investors for patience.
Glass half-full
Instead of viewing bear markets as a bad thing, begin viewing them through an opportunistic lens. As stock prices are falling, it could be a chance to grab great companies at a discount -- and likely for less than you would've paid for them in 2021. If time is on your side, you could be setting yourself up for greater potential long-term returns.
