Let’s not mince words. Down markets are painful and can be downright scary, but they also present unique opportunities to improve your financial situation.
High inflation, historic rate hikes by the Fed and the threat of a recession can all weigh heavily on an investor’s conscience. Meanwhile, uplifting news has felt pretty hard to come by lately. The most recent core CPI reading — which excludes food and energy — increased 6.6% year-over-year to a 40-year high, while overall CPI hit 8.2%, recording its seventh consecutive month above 8%.
But I have a specific playbook ready when down markets occur. For example, I know that lower stock prices make it easier to rotate out of expensive investments, reduce my tax bill and put more money to work. (The views expressed are those of the author and may not be indicative of others’ experiences.)
Here are some ways that you could take advantage of the opportunities at hand:
Convert a Traditional IRA to a Roth IRA
When evaluating your financial situation, one of the first components to look at is long-term savings. If you currently have a traditional IRA, you may want to consider converting it to a Roth IRA. A Roth IRA requires contributions to be made in after-tax dollars, but with the resulting earnings untaxed if you maintain the account for at least five years and are 59½ or older at the time of withdrawal.
Yes, you will need to pay income taxes on the account balance that’s transferred, but converting when the market is down means your account will likely have less value, resulting in a lower tax bill.
Do Some Tax-Loss Harvesting
Tax-loss harvesting, the practice of realizing capital losses in order to offset capital gains, can also help lower your tax bill. Any losses from investments can be netted against realized capital gains, while additional losses can be used to reduce your taxable income by up to $3,000, or they can be carried over for use in subsequent tax years.
The process is relatively straightforward. You first sell an investment that is trading below your original purchase price. To maintain market exposure, reinvest the proceeds of the sale into another security that fits your asset allocation strategy. The value of the loss you realized then becomes available to reduce taxable capital gains and potentially taxable income.
Slash Fees by Rotating into Lower-Cost Investments
While investing fees may seem small, they can have a major impact on your portfolio in the long run. Take a look at your investments and see where you might be able to switch from expensive funds to funds with lower expense ratios. The tax costs of liquidating positions with large embedded gains can keep an investor in high-cost funds. When markets are down, these costs are also reduced — providing a great opportunity to rotate into a lower-cost investment.
Over a 30-year period, moving from a fund with a 0.47% expense ratio (the average for mutual funds) to a 0.06% expense ratio (the average for index funds) could mean roughly 12% more money in your account.
Get Off the Sidelines
Study after study has shown that time in the market is the biggest predictor of investment success. But even the most disciplined investor might have seen the eye-popping valuations over the last few years and been hesitant to invest new cash. With valuations now coming back down to earth, investors can feel a bit better about deploying that dry powder.
The market and economy inherently fluctuate, but savvy investors know that down markets also present opportunity. Investors should consider using this down market, and any in the future, to put themselves and their portfolios on stronger footing.
Nothing in this communication should be construed as an offer, recommendation, or solicitation to buy or sell any security. Additionally, investors are encouraged to consult with their personal tax advisers about their specific situation.
Adam Grealish serves as Head of Investments at Altruist, a fintech company on a mission to make great independent financial advice more affordable and accessible. With a career rooted in financial innovation, Adam most recently led Betterment's strategic asset allocation, fund selection, automated portfolio management, and tax strategies. In addition, he served as a vice president at Goldman Sachs, overseeing the structured corporate credit and macro credit trading strategies.
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