There are few emotions more uncomfortable than the feeling of losing control. And that’s exactly what many investors feel when the market drops.
As a Cook Wealth Advisor, I’ve walked with clients through a number of high highs and low lows. I’ve heard these questions over and over: “What can I do? How can we get through this? What’s next?”
What many investors don’t realize is that there are a handful of strategies that actually work best when the market drops— helping them make the best of a challenging time.
If the most recent market downturn has you questioning your financial strategy, read on for six things you can do to maximize the market drop— and reach your financial goals.
1. Plan for fluctuations
The best time to plan for a market downturn is before the downturn. The second best time? Today.
At Cook Wealth, we future-proof our clients’ portfolios by making plans that factor in fluctuations. After all, if stocks and bonds didn’t have the ability to go down, they wouldn’t have the ability to go up! This up and down behavior of stock and bond values is a necessary part of building long-term wealth.
While this strategy won’t help your portfolio today, planning for fluctuations will help you stay invested the next time the market wavers.
2. When the market does drop, whatever you do, don’t panic!
When the market gets volatile, and especially when it drops, investors are always tempted to sell off their assets. You may be tempted to sell off even when you have a solid recovery plan in place!
It’s hard watching your portfolio plummet day after day, while news headlines shout about recessions and bear markets. When we’re surrounded by panic-selling, that emotion spreads quickly.
But the truth is, historically, the market has always recovered— and gained some. In most situations, the best thing you can do is hold onto your investment, because selling in the heat of the moment immediately locks in losses.
For most investors, holding onto their investments is the wisest way to handle a downtown. But in some cases, strategically selling off a few stocks or bonds can benefit your portfolio. We’ll look at that situation next.
3. In certain situations, tax-loss harvesting can help you reach your goals
It’s not smart to make significant financial changes driven by emotion or market fluctuations. But when the market does drop, there are a few financial planning and tax strategies we can utilize to help you build wealth even in a downturn.
Tax-loss harvesting is a simple strategy that takes advantage of dips to reduce your taxable gains. When the market is down and you have losses in your portfolio, those losses can be sold and used to offset future gains.
The challenge with tax-loss harvesting is that you’re required to wait 31 days before you can buy back that investment you sold. And chances are, you’ll want to continue holding it because it was a good investment to begin with. So the best thing you can do is find a similar investment you can invest in for the 31-day waiting period, then move those assets back over.
There are some complicated rules and best practices when it comes to picking an alternative investment, so you should always consult your Tax and Wealth Advisors (or use Cook Wealth!) to ensure the loss will be legitimate.
Additional considerations for tax-loss harvesting:
- Harvest short-term losses first. Those are losses on investments you purchased less than one year ago. Short-term losses are used to offset short-term gains, which are usually taxed at higher rates than long-term gains.
- Your losses carry forward. You can use any losses you accumulate for the remainder of your life. They carry forward and can be used against capital gains at any point.
- Don’t have gains to offset? No problem. Losses can also offset up to $3,000 of income per year when filing your taxes.
When tax-loss harvesting, it’s always a good idea to consult with your Tax and Wealth Advisors first to ensure you’re maximizing the benefit
Certain assets should not be used for tax-loss harvesting purposes because other strategies offer even greater benefits.
For example, if you have certain highly appreciated investments, those could be used for future gifting – either to heirs, charities, or a donor advised fund. These are all great destinations for highly appreciated securities. For this reason, it doesn’t make sense to use your harvested losses to offset gains on securities that will be gifted – save those losses to offset gains on the securities you plan to keep!
In the case of gifting securities to an heir, remember, they can often dispose of the gains at a more favorable tax rate. Since your tax rate is likely much higher than theirs, it may make more sense to allow your heirs to pay the tax out of their gift, and maintain your capital losses for other securities in your portfolio.
Can you see why tax-loss harvesting is a strategy best undertaken with your trusted financial advisor? The benefits are great, but there are a number of complexities to navigate along the way.
4. Wait to make a charitable gift of securities
As mentioned above, gifting appreciated securities to charities or donor-advised funds is a very effective tactic for lowering your tax burden and supporting the charities you believe in.
But in a down market, it often makes more sense to hold onto these valuable securities.
When you make these kinds of charitable contributions, you can deduct the full market value of the securities (subject to certain limitations) even though you may have paid significantly less for the security when you first invested in it. When the market is up and the value of your securities increases, so does both your charitable gift and your tax deductions.
Unfortunately, you only get to deduct the amount of your gift at the moment of gifting. There’s no future credit for price increases on that security. So waiting for your securities to regain their value will maximize the amount of your gift and subsequent charitable tax deduction.
In some cases, you may not be able to afford to wait— such as if your tax plan for this year relies on charitable contributions of appreciated stock. In that situation, you should weigh the benefits of the extra value alongside the total tax benefits of your current tax year gift. For instance, if your tax rate is going to fall dramatically in the following year, it likely doesn’t make sense to wait for higher prices on your securities.
As with the tax-loss harvesting strategy, make sure to consult your Tax and Wealth Advisors before you make any significant portfolio changes.
5. Utilize a Roth conversion
When Roth conversions are part of your financial plan, performing them when the market is down is very effective. That’s because when the market is “at a discount” you can essentially convert more shares of the same investment to stay within your budget. This allows all of the “bouncing back” of the market to happen in the Roth IRA, rather than the traditional IRA.
The result? Your traditional IRA will be depleted at a faster rate and your Roth IRA will grow at a faster rate— accomplishing two common goals of Roth conversions.
Roth conversions are a complex topic to tackle and there are many different factors to consider, so be sure to talk with your Wealth Advisor before building them into your financial plan.
6. Consider annual exclusion gifting
As part of your estate planning, annual exclusion gifts may be utilized to decrease your taxable estate without using up any of your gift tax exemption amount.
In 2022, you’re allowed an annual exclusion gift of up to $16,000 per person, or $32,000 per couple.
Similarly to Roth conversions, gifting while your assets are lower in value allows the bouncing back of the value to happen in the account of the person who receives the gift rather than the person making the gift. This can help you reach your estate planning goals quicker— putting more money in the hands of your heirs and lowering your potential estate tax burden in the process.
I’ve said it throughout this article, but I just have to state it one more time for good measure: These advanced financial strategies are best implemented with the help of your Wealth Advisor!
A market downturn may seem devastating. And if you’re heavily invested, it’s true that the losses may be significant. But with these strategies in place, you can make the most of both the highs and lows of investing. Especially when you have a team of financial experts on your side.
Want to learn more about weathering the ups and downs of the market? Grab a 15-minute spot on our calendar. We look forward to connecting with you!