3 Actionable Strategies to Consider When Markets Take A Dump 💩
Except for a small Covid-induced blip in 2020, investors have been lulled into thinking that markets only go up. While “up” is the long-term trajectory of the stock market, this year has rudely reminded us that in the short term, markets can and will be volatile. But your portfolio taking a beating isn’t all bad news. Here are three things you might want to consider taking advantage of as you lick your money wounds.
Roth Conversions
Many of us have the majority of our retirement funds in pre-tax accounts like Traditional IRAs and 401k’s. These accounts allow you to save for retirement while deferring taxes until you withdraw the funds. However, when you do begin taking withdrawals, these funds are taxed as ordinary income, which tends to carry higher tax rates than long-term investments. Plus, they have Required Minimum Distributions (RMDs), which forces you to take withdrawals even if you don’t need it.
While it’s good to be saving in pre-tax accounts, it’s just as good to diversify your tax and withdrawal portfolio. Enter Roth IRAs. In this type of retirement account, you contribute after-tax money and the earnings grow tax free. You’ll never have to pay taxes on this money ever again, based on current law. Roth IRAs also don’t have RMDs, so it’s up to you to decide when to withdraw the funds. So by having both types of accounts (pre- and after-tax), you get the flexibility to control when and how much of your income you give to Uncle Sam.
What does the market dump have anything to do with this, you ask? Well, during times of market downturns, it’s likely that the value of your pre-tax accounts has declined, maybe significantly. If so, it might make sense to convert that lower account balance into a Roth IRA now and lessen the taxes due on it. Once converted, it’s pure tax-free gravy when markets eventually recover. And just to clarify, while you will owe taxes now on the amount you withdraw and convert, you won’t owe the 10% penalty that is usually paid if you withdraw when you’re younger than 59.5, assuming you do this properly.
Tax-Loss Harvesting
If you have funds sitting in a taxable brokerage (i.e. non-retirement) account, you might be sitting on a few (many?) losers. If so, a strategy known as tax-loss harvesting might be your silver lining. Here, you sell those losers and incur a short- or long-term capital loss. You then use the proceeds to reinvest in similar (but not identical) positions. The losses you captured when you sold will offset any capital gains that year plus up to $3,000 in ordinary income. Bam, your tax bill just got smaller. Plus, losses that you’re not able to use this year can be carried forward indefinitely. Bam, your future tax bill just got smaller. But in order for this strategy to work effectively, you have to be willing to buy the same amount that you just sold. That ensures you have the same stock exposure that you started with.
Rebalancing Your Portfolio
Sure, the market is down. But guess what is also down? Stock valuations. Yep, the stock market is a lot cheaper than it was a few months ago. I don’t know about you, but I like to buy things when they’re on sale. Rebalancing your portfolio is a way of getting in on that sale. This involves getting your stock allocation back to its appropriate level by “buying the dump.” It might feel weird to run into a burning house, but history has shown that market pullbacks are followed by short- and mid-term gains. Of course, rebalancing presupposes that you already have an asset allocation to rebalance to. If you don’t, you know where to find me.
You see, it’s not all bad news when markets take a dump. Also, notice how none of these strategies encourages you to bail out of the stock market when it’s down. To the contrary, they reinforce the notion that you’re in this for the long haul. That’s where the markets have historically rewarded investors.
A little cover-my-butt disclaimer: We are not accountants and this is not intended to be tax advice. It’s just a few strategies that you might want to consider after talking with your tax professional and/or financial advisor.
If you’re interesting in learning more about any of these financial planning strategies, get in touch. I’d love to talk through which of these might work best for you.
