Down Markets: How Do You Take Advantage of Their Opportunities?
No matter how much doom-and-gloom you hear about down markets, they can provide investment and tax opportunities. During this period of volatility, here are five strategies to consider.
1. Buy Low
Do you know the saying “buy low, sell high”? A lot of people do the opposite—especially when markets fall. Panicking investors end up selling low and taking a loss. But you can do it right and buy while prices are dropping.
An excellent way to do this automatically is to practice “dollar cost averaging.” That means you invest the same amount each month no matter what the markets do. For example, you probably already do this with your 401(k). This practice helps keep you invested and build your retirement savings over time
If you have extra cash to invest, down markets can be a good time to buy equities. As this Yahoo Finance article points out, you want to look for high-quality companies with “consistent cash flows, strong balance sheets, and, in this inflationary environment, pricing power.”
2. Rebalance Your Portfolio
You should have a set asset allocation as part of your long-term investment strategy. Over time, your portfolio will veer from the desired allocation.
Consider using a down market to rebalance your portfolio to your strategy’s asset allocation since you’ll buy equities at a lower cost.
3. Complete Tax Loss Harvesting
Market drops are also an opportune time to consider tax loss harvesting. This means you sell losing investments to offset any gains you have made.
You aren’t limited to using your investment losses in the same year you sell. You can carry over those losses to offset gains in future years. You can also carry over your losses to offset up to $3,000 in ordinary income, which can be valuable in years you face higher income taxes.
We suggest you talk to a financial advisor or tax professional before harvesting losses since you must navigate certain regulations, such as the wash sale rule. This rule bars you from selling a security at a loss and buying a “substantially identical” security within 30 days.
You’ll also want to match short-term losses with short-term gains (which would be taxed as income), and long-term losses with long-term gains (which incur capital gains taxes).
4. Complete a Roth Conversion
With a Roth IRA, you pay taxes on your contributions now, not when you make withdrawals in retirement.
You also aren’t subject to required minimum distributions (RMDs) with a Roth account.
However, many high-income earners can’t contribute to Roth plans because of IRS income limitations. So they use a Roth conversion as a workaround.
With a Roth conversion, you convert a traditional IRA to a Roth IRA, or a 401(k) to a Roth 401(k). Our Roth conversion article covers the benefits and downsides in more detail, but briefly, a down market can be a great time to complete a conversion since the value of your portfolio has dropped. That reduced value means you pay fewer taxes on your conversion.
5. Reinvest Your RMD
You sell at a loss if you must take an RMD during a down market. Assuming you don’t need the money for everyday expenses, you can help offset the loss by reinvesting the proceeds into a taxable account, like your brokerage account. You then wait for your investments to recover before cashing them out.
Brokerage accounts are subject to taxes, but this move could help you recoup losses from taking your RMD during a low market point. Talk to your financial advisor to determine if this strategy is for you.
Final Thoughts
It can be stressful to watch your portfolio value decline during a market drop. However, market downturns offer a silver lining. You could turn the volatility to your advantage by buying low, rebalancing, harvesting losses, doing Roth conversions, or reinvesting RMDs.
Our fiduciary wealth management firm in Roseville and Folsom, CA, and Lehi and Logan, UT, works with clients on strategies such as these as part of their ongoing financial planning and investment management. Consider consulting with a fiduciary financial advisor to make sure any potential strategies are compatible with your long-term goals.
Schedule a complimentary, 15-minute call with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor with offices in Roseville and Folsom, CA, and Lehi and Logan, UT. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country’s leading professional association of fee-only financial advisor