4 good strategies when markets are bad.
KEY TAKEAWAYS
Take losses in your portfolio to improve tax efficiency.
Make the most of your Employer Plan during corrections.
Implement a dollar-cost averaging strategy to have excess cash invested in the market at different levels.
Create tax-free growth so more of your dollars go towards supporting your lifestyle instead of paying taxes.
After a very welcome relief rally between June and August, market volatility is back. While big market swings can feel unnerving, it’s important to remember that this is an inherent part of investing. Any time we invest, we take on short-term volatility in exchange for long-term gains.
Don’t let your emotions rise and fall with the markets. If you keep your focus on the long-term and on the things that you can control, you’ll be able to see the opportunities markets present during times like this.
Here are four potential actions that can help your bottom-line.
Give Yourself a Tax Break
While losses don’t feel good, they can be used to increase the tax-efficiency of your portfolio and/or manage your tax liabilities.
Individual, Joint, and Trust brokerage accounts are called “taxable” accounts because the sale of an investment creates a taxable event – a gain or a loss. During environments like this, you may have entire positions or specific tax lots that have losses. Tax Loss Harvesting is a tax strategy where you sell these positions to realize losses and use those losses to:
Offset realized gains with losses: If you realized gains in the same year, your losses can be used to partially or completely offset these realized gains.
Offset your ordinary income: If you realize more losses than gains, you can use up to $3,000 to offset your ordinary income.
Carry forward losses: If you still have losses left over, they can be carried forward to future years to offset future realized gains and/or offset $3,000 in ordinary income.
NOTE: One thing to be aware of when utilizing this strategy is a wash sale rule. You cannot repurchase the same investment for 30 days. If you do, the tax loss you claimed would be disallowed – defeating the purpose behind taking the loss in the first place. .
Contribute More to Employer Plan
We all know the adage, “buy low, sell high.” There’s no better time to buy low than during market corrections.
You invest in your 401(k) or 403(b) Plan every pay period. During market corrections, you can increase your contributions so that you have more money going into the plan now, while prices are low. If you’re on track to max out, you will just max out earlier in the year. Most plans will automatically stop your contributions once you’ve reached the 2022 IRS limits of $20,500 or $27,000, but make sure that’s the case with your plan.
Already maxed out your pre-tax and/or Roth contributions?
Your plan might offer an After-Tax option with a Roth conversion feature. This after-tax option is not the same as the Roth 401(k) and requires careful planning. When done properly, it allows you to contribute above and beyond the IRS limits stated above and then have those dollars grow tax-free.
Put Extra Money to Work
If you have excess cash on hand – beyond your emergency fund – consider implementing a dollar-cost averaging strategy. Dollar-cost averaging is investing equal amounts of money at regular intervals, regardless of what’s happening in the market. Similar to how you contribute to your 401(k) each pay period, this is an automated contribution strategy that will take emotions out of the equation and allow you to phase your money into the market at different levels.
One big benefit of dollar-cost averaging?
Flexibility. You can always dial it up or down whenever you'd like.
Speed up contributions: Make more frequent contributions while prices are low.
Increase dollar amount: Make a larger contribution than what is scheduled.
So, during times like these when the global stock market is down more than 18% this year, you can put more money to work at lower levels.
Create Tax-Free Growth
NOTE: Thorough and careful tax planning is required for this strategy. If done correctly, the long-term benefits for you and/or future beneficiaries are significant.
If you’re like most people, you have most - if not all - of your retirement savings in pre-tax balances. These balances have not been taxed but will be taxed at ordinary income rates when you start taking distributions.
This presents big risks people don’t consider.
First, after taxes, how much of this money is actually yours? We don’t know what income tax rates will be in five years let alone 25 years. If there’s a meaningful increase in tax rates, you’ll have more money going to taxes instead of supporting your spending needs.
Another risk is the ripple effect of having more reportable income. Distributions from your 401(k), 403(b), and IRA are considered income, which can impact taxes on Social Security benefits and increase your Medicare Part B premiums. Once again, the result is less money going towards funding your lifestyle in retirement.
A way to manage this future income tax risk is to build out your Roth allocation (which is tax-free) as early as possible. Roth conversions are one way to accomplish that and are especially powerful during market corrections. With Roth conversions you are electing to pay ordinary income taxes on the balance you are converting now, so that the balance will grow tax-free.
When share prices are lower, you can convert a greater number of shares with the same tax liability. When the market recovers and continues to move higher, you will have that many more shares growing for you tax-free.
Conclusion
Making money decisions based on emotion is almost never a good thing. We can’t control the markets, but we can control how we respond. When your investment strategy is backed by a financial plan tailored to you, you’ll be confident and able to see through the market chaos.
The market is always presenting opportunities. You just have to know where to find them.
Katie Blechschmidt, CFP®
Director of Client Success