What to do in a down market! A declining market can easily turn an investor’s appetite sour. Anytime money is involved we can become emotional and focus on the wrong things; usually it’s short-term price swings instead of our long-term goals. Investing should be an emotionless activity in which we are always looking at the markets through an optimistic lens. Very simply put, markets were at all-time highs 5 months ago. Since 1928, there have been 26 declines of 20% or more in the S & P 500. Each one has led to new highs in the market. In general, it’s best to stand pat and focus on the long term… Especially at times like this! I believe there are also ways to be proactive in a down market that will plant good seeds for the inevitable new market highs the future holds. Here are 3 ways to be proactive in a down market…
1. Max Out your retirement account for 2022 now:
The best way to plan for the future is to make our IRA contributions every year. This is how you dollar-cost average and build up your retirement account over time. I’ve noticed that most clients make their contributions in 1 of 2 ways. Either by depositing an equal portion of their yearly contribution every month; or by making a lump sum deposit right before tax time. Make no mistake, there is no right or wrong way to fund your IRA. The important thing is funding it!
However, maxing out your retirement account right now can have a major long-term benefit. I am not saying you should become a market timer with your contributions but very simply put… Putting money to work with an S & P down 19% from its high and a Nasdaq down 29% from its high (*at the time of writing this) has historically been a great time to invest if you have a reasonable time frame. If you plan to max out your IRA for 2022 at some time then I would highly consider pulling those contributions forward and making them now.
2. Convert Your IRA To A ROTH IRA:
A ROTH Conversion has some potential great long-term benefits. I will cover in a future post more details about this tax strategy but wanted to broadly touch on it now. Traditional, Simple, SEP IRA’s, and 401K’s are retirement vehicles that get funded with pre-tax dollars. This gives you a tax deduction for the year and all funds are invested tax-deferred until withdrawal. All withdrawals after 59 1/2 get added to your income for that tax year. A ROTH IRA is funded with after-tax dollars. Although you do not get a write-off for your annual contribution; all Qualified Distributions are completely tax-free. There is also no required minimum distribution at the age of 72.5 which allows you to pick and choose if and when you will take a Qualified Distribution. This gives you greater control of your taxable income in retirement.
Now, why would now be a good time to do a ROTH Conversion? Markets are down, and likely your account values are down as well. When you do a ROTH Conversion you are paying taxes that year on the amount you convert. So, you can potentially be paying taxes on a lower dollar amount as the value of your account has declined over the past 6 months. Pay those taxes now instead of when you withdraw the funds in retirement. If you believe the market will be higher in the future then converting to a ROTH now could lead to tax-free appreciation as the market recovers.
ROTH Conversions can also benefit a retiree who will not need to tap into their retirement account for their living expenses because there is no required age to start taking withdrawals as tax-deferred retirement accounts have. If you never need to tap into your ROTH IRA in retirement then your beneficiary will inherit your ROTH tax-free as well.
To sum it up, a ROTH Conversion may lead to a lower lifetime tax bill and tax-free money in your retirement. There are a lot of caveats with ROTH Conversions, but this is something that might be attractive to you as a long-term tax strategy. Whether you consider doing a full or partial ROTH conversion you should discuss this strategy first with your financial advisor and accountant.
3. Tax-Loss Harvesting:
I believe all investments should be reviewed on an ongoing basis. It’s simple, THINGS CHANGE! The reasons you bought something in the past may or may not still exist today. Just because a position is down does not mean you should be liquidating it, but down markets call for a good hard look at all your holdings. Ask yourself this… Do I still want to be holding a particular stock or fund moving forward? If I didn’t already own this would I purchase it now? If the answer is no; then it might be best to sell the position and re-allocate the funds.
Selling a down position does have its benefits. You can offset that loss against any capital gains you incur for the year. You can also carry forward that loss and potentially write off $3000 per year of ordinary income. Another great benefit of selling a losing position is that you can now reinvest in something that has a better potential moving forward. We are all wrong at times which is ok… Staying wrong isn’t!
One more way to use this strategy is if you still like the fund you are in but want to take advantage of the tax benefits that selling a losing position provides. Let’s say you are invested in a growth-focused fund and still like growth long term. Sell your current holding and buy a similar holding from a different fund company. The good thing about all the big fund companies is that they offer similar funds to invest in. Use the fact that most larger fund companies don’t differentiate themselves from each other to your advantage. The tax loss will be realized and you can still have your exposure to the same area of the market. *Just make sure that you are not buying an “Identical” fund to avoid the wash sale rule.
Always Remember:
Market volatility is nothing new and will always be with us. An average investor can experience 10-15 bear markets in their lifetime. Becoming too negative about anything in life is never a good thing and often clouds our vision. Keeping focused on your long-term plan is what matters. Stay patient, stay disciplined, stay long term, and most of all BE PROACTIVE!