Published by Taylor Maks | Client Relationship Manager
Though it may be easy to forget, market downturns are inevitable and almost always catch you by surprise. They almost lull you to sleep, or at least the bull market over the last decade or so has. Eventually though, the alarm goes off, and its time to get up. But that is the way markets are, they go up and they go down, and sometimes they go down a lot faster than they go up, especially in this recent selloff caused by the novel coronavirus.
It is easy to panic during these times when people see their investment portfolios down , fifteen, twenty, twenty-five percent, the market commentators on TV seem to be discussing the end of the world, and every new headline on the internet involves the most recent large move in the stock market. This is human nature. Feeling uneasy is normal at these times. But just because you feel uneasy and concerned does not mean that you cannot take advantage of some of the opportunities a market downturn provides. Aside from the benefits that will be described below, making some of these choices may make you feel better. Part of what makes market crashes so hard to stomach is the lack of control people feel. Here are a few things that you can do (and take control of) to take reflect on or take advantage of during this market downturn to set you up for a better future.
- Re-evaluate your risk tolerance
First and foremost, now is the appropriate time for investors to re-evaluate the amount of risk they are willing to take on in their investment portfolio. This is a vital decision for any investment or financial plan. This is the ideal time to really evaluate your risk tolerance level because during a market downturn it is easier to feel and conceptualize how much are you willing to stomach?
There are multiple factors that should be considered when evaluating your risk tolerance such as age, investment time horizon, are you contributing or withdrawing from the portfolio, how large is the portfolio, etc. Most important of all though is personal comfort level. The last thing an investor wants to do is overestimate his or her tolerance for risk. When a market goes up steadily, it is easy and tempting to take on more risk, but when a downturn occurs, their portfolio is down significantly, and they decide they can’t stomach any more losses and sell at exactly the wrong time, this is when trouble occurs. It is more important to have an appropriate risk tolerance that aligns with an investment strategy one can stick to, even it if means sacrificing some of the high-flying gains on the way up.
- Be Tax Smart
Utilizing market downturns to help optimize current and future taxes is a very productive use of what is otherwise a trying time. Below are a couple of ways to use it to your advantage:
- Roth Conversions
Market downturns are a great time to move money from a tax-deferred retirement account to a tax-free Roth account by utilizing Roth Conversions. For those who have traditional 401(k) accounts, it may be advantageous to inquire you’re your 401(k) plan to see if they allow for in service rollovers or Roth conversions within the plan. Where this is most advantageous is by converting securities in an IRA to a Roth while keeping them invested. For example, prior to a market downturn, an investor had $1,000 shares of stock ABC at $50/share in a traditional IRA. The market downturn occurs, and the same stock is now worth $35/share. Given that Roth conversions are taxed as ordinary income, the had the investor converted at the peak, he or she would have incurred $15,000 ($50,000 vs $35,000) more in tax liability for the conversion but transferred the same number of shares! Take advantage of the market downturns if Roth conversions make sense for you, when the market eventually rebounds, your future self will thank you.
- Tax-loss harvesting
Even though it hurts when an investment loses value, sometimes it can be utilized to your advantage. Tax-loss harvesting allows you to take advantage of selling some of the investments that have incurred a loss and potentially utilize those losses to offset some of the investments that may still have gains in the portfolio. You can also offset up to $3,000 of ordinary income in a year after capital gains have been offset. If the losses incurred are greater, you can carry forward those losses indefinitely.
A few things to remember, short term losses will first offset short term gains and long-term losses will first offset long term gains. This is important to remember as the short-term capital gains are taxed as ordinary income rates while long term capital gains have tax advantaged rates up to no more than 20%. (23.8% if you are a high-income earner and are subject to NIIT*.) Tax-loss harvesting is an exercise that should be conducted throughout the year, but market downturns are a great time to do so given there are usually more opportunities.
- Diversify away highly appreciated securities
Having stocks, bonds, ETF’s, etc. that have appreciated greatly over time is certainly not a bad problem to have. But, after such an increase in the value, sometimes people hold onto a highly concentrated position because they do not want to realize the taxable gain. Understandable. An unintended consequence of having positions like this though, can be an increased risk profile to their entire portfolio given the percentage one or two of the highly concentrated positions make up.
Assuming that a market downturn does not completely eat away at all of the gains in the investments, now would be a great time to take a bit of risk off the table and diversify some (not necessarily all) of the position away without having as much of a tax liability. This also provides an investor to diversify while the market is down and potentially allowing cash to be freed up to purchase other attractive investments while they are “on sale,” or rebalance a portfolio to an appropriate risk level.
- Put some of that cash to work
Many people and businesses have been keeping some cash on the sideline for years now as they were waiting for the market to “pull back.” No one knows when the markets will reach their bottom, just like no one knows when they will peak. What we do know is that there are a multitude of investments that are much less expensive now than they were a month or two ago. This is an opportunity for many people, especially those with longer time horizons, to either continue to invest on a regular basis, or start putting some of the cash on the sidelines back into the markets. Again, we do not know when the market will find a bottom, but we do have a strong inclination to believe, if history is any indication, that at some point the market will rebound and the investments made in the downturn can be rather rewarding. As Warren Buffet says, “Be fearful when others are greedy, and be greedy when others are fearful.”
- Pay Less Interest and Refinance Debt
It is natural, even prudent, during these kinds of downturns to feel try to find ways to cut down on monthly costs. One effective way of doing this is to re-evaluate current debt obligations and terms. When the stock market falls, interest rates usually follow suit. This is generally because of investor behavior fleeing to “safer” assets like US Treasuries as well as the Federal Reserve’s use of monetary policy.
Taking advantage of these low rates can increase monthly cash flow for individuals and businesses alike and can be a positive in otherwise rather dull times. Refinancing a mortgage is a great way to reduce a mortgage payment or allow you to continue to make the same payment but allot more towards the equity in the home and pay less interest! For example, say you are currently making payments on a 30-year 4.125% fixed rate mortgage with an original loan value of $320,000. There is $300,000 remaining. If you refinanced into another 30-year mortgage with a rate of 3.5%, your payment would be reduced by over $100/month.
There are two ways to take advantage of this. You can choose to keep paying the same monthly amount building the equity in your home by over $100/month more or you could reduce the monthly payment to the new required payment and save the extra money! Taking it a step further, for those who have other debt obligations like a HELOC or an auto loan, which generally carry higher interest rates than traditional mortgages, now might be a good time to refinance and roll those other loans into a mortgage to take advantage of lower interest rates.
- Refocus and Keep Living!
It is easy, and natural, to get caught up in worrying about what your portfolio is doing on a day in and day out basis, especially when everything you see and hear is negative. What does not help is to look at it every day! Remember to keep living and focus on the important stuff in your life whether that be faith, family, friends, pets, romantic comedies, whatever it is. With patience and prudence, your investment losses can be recouped, but what cannot be, is the time spent worrying about them. This is the most important thing an investor can do during these times.
And heck, if all else fails, take it from Will Rogers and remember that “The quickest way to double your money is to fold it in half and put it back in your pocket.”
*Net investment income tax – applied at a rate of 3.8% to certain net investment income to individuals and households that earn above the statutory thresholds.
The views stated in this piece are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to by or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.