News of the U.S. government's credit rating downgrade and how the Dow Jones has lost over 12% in the past 10 days has gotten Wall Street bankers and retirement plan holders in a frenzy. The dive in the market has unfortunately reminded us of 2008's market downturn, when many saw their retirement plan shrivel to only 60% of its original value.
But there can always be a silver lining in a market downturn. If you're optimistic and believe a strong economy and a bull market will follow after the dust has settled, you could be amply rewarded. You just have to know how to take advantage of a downturn and seize the hidden opportunities -- in and out of the market -- that are available to you.
1. Buy the Market While It's on Sale
We buy clothes and shoes when they're on sale and we stock up on cereal when it's on clearance, why not do the same with the stock market while it's a bargain?
If we learned anything from the financial crisis of 2008, it's to be brave and invest in the stock market when prices are low and fear and pessimism are running rampant.
Sound like a dangerous game? Consider this:
At its low in March 2009, the S&P 500 was sitting at 683 points, down 26.6% from the beginning of the year. While the rest of the world was complaining about the falling stock market, smart investors decided to go against the grain and bought shares of the SPDR S&P 500 ETF (NYSE: SPY) -- an exchange-traded fund (ETF) that mirrors the S&P 500 -- for $70 each. A little over two years later, the S&P climbed to 1,300 points, and the SPDR S&P 500 ETF shares grew along with it to $130 each for a whopping 85.7% gain.
At the time of this writing, the S&P 500 is on sale for 17% off its recent peak, and 27% off its 2007 highs.
Want to get in on the sale this time? Two great U.S. broad market ETFs with super-low expense ratios include Vanguard's Total Stock Market Index (NYSE: VTI), which invests in over 6,500 small, mid- and large-cap U.S. stocks, and the SPY exchange-traded fund mentioned above, which tracks the S&P 500 index.
Do you or your spouse have gold jewelry that's been sitting in a jewelry box, unworn for years? Or did you get swept up in the recent gold fever and buy more than you originally intended? You'd be smart to take advantage of gold's high value right now -- the precious metal has reached historic highs, trading at over $1,750 an ounce.
While it's absolutely possible that gold prices will continue to rise, keeping all your eggs in one basket has never been a wise investment move. If a considerable amount of your money (20% or more) is tied up in gold, you may compromise and sell off at least some of your gold to take advantage of the high prices.
Why in a down market? Large market swings will cause the value of certain investments to grow while others fall, which can cause the asset allocations in your portfolio to become seriously out of whack.
#-ad_banner_2-#For example, let's say your retirement portfolio is originally made up of 50% stocks and 50% bonds. Then there's a market downturn, which causes the value of your stocks in your retirement account to fall 30% in value. The bonds in your retirement portfolio, however, hold their value steady the entire time. By the end of the downturn, your portfolio would end up with a much different mix of 41% stocks and 59% bonds.
So what's the problem? If you don't rebalance your portfolio back to the way it was before the downturn, you'll miss out when the stock market comes roaring back because you won't have as much of your money in stocks.
Rebalance the assets in your retirement portfolio one to two times a year as needed to keep your returns strong and investment goals on track.
[For more on how to keep your 401(k) plan balanced and delivering healthy returns, see 5 Surprisingly Easy Ways to Overhaul Your 401(k).]
4. Convert to a Roth IRA to Save Big on Taxes
Have a traditional IRA that you've been meaning to convert to a tax-saving Roth IRA? A market downturn is the best opportunity to do it.
Typically, when you convert funds from a traditional IRA to a Roth IRA, you must pay income taxes on the amount converted.
If you have $50,000 in a traditional IRA and you want to transfer (convert) all of the funds to a Roth IRA, you'd have to pay normal income tax on that $50,000. If you're in the 25% tax bracket, it will cost you $12,500 when you file your taxes.
But in a down market, your portfolio's value will be worth less, so you'll pay less tax when you convert than you would have in normal times. Let's say your traditional IRA portfolio before the downturn was worth $50,000, and after a few weeks, the market plummets 20%. Your portfolio would then be worth $40,000. Making a conversion while the value is lower would save you $2,500 in taxes in this example.
[Want to know what tax bracket you're in? Click here to see the federal income tax brackets for 2011.]
Then, once you've retired, you'll be able to happily withdraw funds from your Roth IRA without having to pay any additional taxes on the funds.
[For tax-free withdrawals before age 59 1/2, see: 5 Safe Ways to Tap Your Roth IRA Before You Retire.]
5. Get Ready to Stock up on Clothes and Necessities
If you've been waiting to buy sensible new clothes, shoes or electronic items, get ready for big sales over the next few months. During the last recession, shoppers enjoyed deep discounts up to 70% off department store clothes, cell phones and many other items.
Don't buy needlessly, but if there's a big-ticket item that you've been waiting a while to purchase, wait for the price to drop and nab it while the going is good.
6. Trade in Your Gas Guzzler for a Fuel-Efficient Car
From 2008 (pre-recession) to January 2009, gas prices dropped an astounding 58% -- from $3.80 to $1.61 a gallon. If the price of oil goes down this time (which it already has -- from $99 a barrel in late July to $82 in August), the demand for fuel-efficient new and used cars will ease as well, which may mean lower sticker prices over the next few months.
But there's another opportunity here as well. As the price of oil goes down, the demand for many larger (and more gas-guzzling) vehicles will increase, since car buyers will not mind the fuel costs as much as they used to. If you've wanted to sell your SUV, wait for oil and gas prices to drop to lower levels and then trade in your car for a more efficient one when the deals are abundant.
[Need help deciding on a new car? See our list of The 20 Most Affordable, Fuel-Efficient Cars on the Market.]
The Investing Answer: No one knows for sure if the current market downturn is going to be a double-dip recession, or if the markets are just having a short-term temper tantrum. But that's why it's a win-win. If there's no bear market, we can rest easier knowing that the economy is still going to keep growing. But if there is a bear market and a subsequent recession, you'll know how to take advantage and prepare for a financially stronger future.