The past year has been a catastrophe for many investors. Brutal inflation and rapidly rising interest rates triggered recession fears, causing the stock market to sink like a stone. The S&P 500 and the Nasdaq Composite dropped into a bear market, and both indexes have declined for three consecutive quarters for the first time since 2009.
The market downturn has destroyed trillions of dollars in wealth. But the world keeps turning, and the end of the year is fast approaching, bringing with it important deadlines and opportunities. Here are two ways smart investors are preparing for 2023.
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1. Smart investors are selling (select) stocks
Every investor will lose money in the stock market at some point, even the brightest minds on Wall Street. In fact, Berkshire Hathaway's portfolio, which is managed by Warren Buffett, has fallen in value by over $40 billion this year. But there is a silver lining to losing money in the market.
Investors can deduct up to $3,000 in capital losses (net of capital gains) from their taxable income each year, provided they sell the stock from a taxable investment account before the end of the year and do not repurchase the stock within 30 days. Additionally, any capital losses exceeding $3,000 can be carried into future tax years.
To clarify, don't sell a stock just because its share price has declined. But the end of the year is a good time to reevaluate your portfolio. If you find any stocks with a broken investment thesis -- meaning you no longer have confidence in the underlying business -- consider selling those securities before the end of the year, especially if they are in the red.
In the third quarter, Buffett sold more than $5 billion in Berkshire stocks, reducing his stake in Activision Blizzard, General Motors, and US Bancorp, among others. As a caveat, investors should not assume Buffett lost confidence in those businesses. Smart investors sell stocks for other reasons too. For instance, Buffett may have been uncomfortable with the size of his stake in those businesses.
2. Smart investors are buying stocks
Investing legend Peter Lynch once said, "A correction is a wonderful opportunity to buy your favorite companies at a bargain price." Indeed, bargains abound in the market today. The world is full of great businesses with bright futures, and many of those businesses have seen their share prices slashed this year because some investors feel safer sitting on the sidelines right now.
But economic turbulence is temporary, and the stock market will inevitably rebound, just as it has rebounded from every downturn in the past. Missing that rebound could be a very costly mistake.
Here is a perfect example: The S&P 500 climbed 517% during the two decades ending on Dec. 31, 2021, meaning any investor that bought and held an S&P 500 index fund during that time would have realized sixfold returns. But if that investor had missed the 10 best trading days during those decades, their investment would have grown less than threefold. And guess what? During that time, all the market's best days occurred during a bear market, or during the month following the end of a bear market (i.e., before it was clear that a new bull market had started).
For that reason, smart investors like Lynch and Buffett know bear markets are buying opportunities. In fact, while Buffett has sold about $17 billion in Berkshire-owned stocks this year, he has also purchased $66 billion in stocks, meaning he has been a net buyer throughout the downturn.
As a caveat, not every fallen stock is worth buying. Investors should look for businesses that benefit from a durable competitive advantage, especially those that compete in large and growing markets. That includes industries like e-commerce, digital advertising, and cloud computing, among many others.
