3 Financial Planning And Investment Opportunities In A Down Market

Most investors seek to avoid downturns in the financial markets. Unfortunately, volatility is an unavoidable part of being a long-term investor. The best time to plan for any type of volatility or financial crisis is in advance. But, even down markets and short-lived selloffs can present financial planning and investment opportunities. Here are three money moves to consider when the stock market is down.

Put Extra Cash To Work

With few exceptions, keeping excessive amounts of cash hurts your ability to build wealth. Even in periods of higher interest rates, the real return on cash after taxes and inflation can be negative. Over the long run, only the equity markets have the potential to earn returns that outpace inflation. This can make the difference in having enough money to retire.

As illustrated in the chart below, over prolonged periods, returns on cash (Bloomberg 1-3 month Treasury Bills as a cash proxy) is far below gains on investments in stocks and bonds.

If you have too much cash on hand as a long-term investor, a market downturn may present an opportunity to put sidelined cash to work in your portfolio. So if stocks are down, consider it an opportunity to buy more shares for the same level of investment. To smooth the ride, consider dollar-cost averaging cash into the market.

It’s common for investors to feel apprehensive about investing when the markets are volatile. But it’s also common for those same investors to regret not investing when things eventually improve (and are more expensive). In another words, why wait for higher prices if you can buy something on sale today?

Tax-Loss Harvesting

Tax-loss harvesting means selling securities that have lost value in your portfolio, realizing losses for tax purposes. Losses can offset taxable capital gains, and potentially ordinary income by up to $3,000 in the current year. Any remainder can be carried forward to future years. For investors with a brokerage account or living trust, tax-loss harvesting could present a tax planning opportunity.

Netting gains and losses

Your taxable capital gain or loss ultimately depends on how your gains and losses net out at the end of the year. The process for netting capital gains first applies to gains and losses of the same holding period: long-term gains against long-term losses, and separately, short-term gains against short-term losses. If the resulting short-term and long-term figures involve a gain and a loss, they are netted once more.

Wash-sale rules are one of the most important parts of tax-loss harvesting to be aware of. Under the wash-sale rule, if an identical or substantially identical asset is purchased within a 30-day period (before or after) when an asset was sold for a loss, the loss will be disallowed.

Harvesting losses can be a good way to:

Roth Conversions With Shares

A market downturn or selloff in the stock market could actually be helpful for investors looking to convert pre-tax money to a Roth IRA. When you convert from an IRA to an after-tax Roth IRA, the amount converted is included in your taxable income. It’s not typically advantageous for high-earners to do Roth conversions while working, but in retirement or market downturns, it may be worth considering.

Instead of selling your positions and converting cash, consider converting the ETFs or mutual funds instead. This way you won’t be out of the market or incur additional transaction costs. Again, although no one likes a down year in the financial markets, it can be a good time for Roth conversions as market values are depressed. This can enable some taxpayers to get a bigger Roth payoff for the same tax liability.

Why convert? 4 main benefits of converting to a Roth IRA:

1. No required minimum distributions (RMDs)
2. Tax-free withdrawals if requirements are met
3. Leave a tax-efficient inheritance
4. Greater flexibility for tax planning opportunities in retirement

Before taking any action, always weigh the pros and cons as it relates to your personal financial and tax situation.

When markets give you lemons…

We don’t dictate market movements, but we do determine our reactions. During bouts of volatility, many investors feel the urge to act in ways that can hurt them financially. Although these three money moves won’t make sense for every investor, in the right situations, it may be a path to turn market challenges into strategic opportunities.

This is a general communication should not be used as the basis for making any type of tax, financial, legal, or investment decision.