Five ways to make the most of a market downturn

Posted by TEBI on April 11, 2020

Five ways to make the most of a market downturn

 

By RICK FERRI

 

A virus is spreading, stocks are falling, anxiety is rising, people are huddled in their homes, listening to and reading about talking heads predicting the world will never be the same again. Do you believe it?

You’ve seen this movie before, and the ending isn’t any different this time. Eventually the world will right itself, things will get back to normal, and all will be well in the neighborhood. If you also believe this too shall pass, what should you do today to make your financial situation better for the future?

Here are five ideas:

 

Tax-loss harvest 

If you have stocks or stock mutual funds in your taxable account that are losing money, harvest those losses. You can use tax-losses from harvesting to offset realized capital gains that result from selling securities this year at a profit, selling other investment assets where you’ve made money, and, if your mutual funds distribute capital gains at year-end, you can use losses to offset those distributions. You can also use tax-loss harvesting to offset up to $3,000 in non-investment income.

Tax-loss harvesting is a strategy that only applies to taxable accounts. Tax-deferred retirement accounts like IRAs and 401(k)s grow deferred, so they aren’t subject to capital gains taxes. Consult your tax adviser if you have questions.

 

Switch into total market funds 

You don’t want to be a market timer because we don’t know where the bottom is or if you’ll get back in on time. To stay in the market after selling your stocks or mutual funds, swap into something comparable by not substantially identical to avoid IRS wash sale rules. One great way to stay invested is to swap into total stock market index funds. Over time, total market index funds and ETFs outperform a vast majority of actively managed mutual funds because the fees for index funds are so low. 

For US stocks, I recommend any of the following:

  1. iShares Core S&P Total U.S. Stock Market ETF (ITOT)
  2. Schwab U.S. Broad Market ETF (SCHB)
  3. SPDR Portfolio Total Stock Market ETF (SPTM)
  4. Vanguard Total Stock Market ETF (VTI)

For international stocks, I recommend any of the following:

  1. iShares Core MSCI Total International Stock ETF (IXUS)
  2. Vanguard Total International Stock ETF (VXUS)
  3. Vanguard FTSE All-World ex-US ETF (VEU)

 

Rebalance your portfolio 

Rebalancing means adjusting your holdings to realign your portfolio with your desired long-term asset allocation. There are benefits to rebalancing occasionally in that it controls portfolio risk and, at times, result in a higher return. Let’s say your asset allocation is 60 percent stocks and 40 percent bonds. The market is down now, so you would sell bonds and buy stocks to bring your allocation back to those levels.

Maintaining your asset allocation is counter-intuitive to what is happening in the market, and that makes it hard. Buying stocks after losing money is rattling, and talking heads make matters worse by saying do the opposite because they almost always predict the future trend will be like the immediate past. You need to put all that aside. Rebalancing creates benefits after the hard times pass, and there’s no reason to believe it won’t help again this time.

 

Make your 2019 IRA and Roth IRA contributions 

April 15 is approaching quickly. If you did not contribute to an IRA or Roth IRA in 2019 and you’re eligible to do so, now is as good a time as any. The annual contribution limit for traditional and Roth IRAs is $6,000 total across both account types for those under the age of 50 and $7,000 for people 50 and over.

Tax deductions for traditional IRA contributions begin to phase out at certain income levels if you or your spouse have a workplace retirement plan. You’ll lose your deduction entirely once your income is too high, but you can still make nondeductible contributions and may still use that contribution to do a backdoor Roth conversion. Check with your tax adviser.

 

Do a Roth conversion 

If you have money in a tax-deferred account and it makes sense based on your current and future expected tax brackets, you could use the down market to make a Roth conversion, then buy stock index funds with that money in your Roth account. A Roth IRA conversion involves moving all or part of a pre-tax retirement account, such as an IRA or 401(k), into an after-tax Roth account.

To do the conversion, you would pay income taxes now on the amount of the conversion while the market is down. Individual tax rates are low under the Tax Cuts and Jobs Act, so it makes the option even more appealing. This will shift more money from your pre-tax savings to tax-free savings, and that should benefit you in the long-term by having less in pre-tax accounts that you’ll have to pay taxes on later. Speak with your tax adviser before proceeding.

 

RICK FERRI runs Ferri Investment Solutions, a pay-by-the-hour financial advice service, and is based near Austin, Texas. You can follow him on Twitter @Rick_Ferri.
More articles by Rick Ferri on TEBI:

Vanguard’s Personal Advisor Services — anything but personal

Ten reasons not to invest

Messy funds and the illusion of skill

Points to consider when investing a lump sum

A radical way of staying the course

Just stand there

 

 

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