4 Ways to Take Advantage of a Down Market

The S&P 500 is down 12.5% from its 52-week high as of 8/25.  The Global Dow is down closer to 14%.  The drop has been quick and broad.  This has caused many investors to be nervous and fearful of a larger decline similar to 2008. 

Time will tell if this turns in to something worse, but most investors should keep a long-term view and stick with their game plan.  Those who have a sound financial plan know they are investing towards a goal; the day-to-day, month-to-month changes in the market do not affect their plan.

Keeping that in mind, many people will ask: what should I do?  There are some things investors should consider while the market is temporarily down.  Here is my short list:

1. Tax Loss Harvesting – Those who have non-retirement brokerage accounts have the opportunity to sell an investment that has lost money and write off that loss on their tax return.  Here is an example:

You pay $10,000 for shares of XYZ mutual fund

The value of your shares drops to $7,000

If you sell the shares, you realize a $3,000 loss on your investment

You can take the $7,000 of proceeds from the sale of XYZ and reinvest in another mutual fund that is similar but not identical (to avoid wash sale rules).  Reinvesting in something similar allows you to recoup your loss if that asset class recovers. 

The losses you realize will help offset any capital gains you have realized in the same tax year.  If you have no capital gains, you are allowed to claim up to $3,000 in losses on your tax return to offset your ordinary income. Assuming you were in the 25% marginal tax bracket, this offset against ordinary income would save you $750. Lastly, if you have more than $3,000 in losses, the remaining balance carries forward to offset taxes in future years.  Obviously, tax loss harvesting is a powerful strategy.

2.  Roth Conversions – Few people realize that a large stock market decline is a great time to consider converting a traditional IRA to a Roth IRA.  There will be taxes owed at the time of conversion, so make sure you have the cash available outside of the retirement accounts to pay the bill. Here is how a conversion may be wise during a decline:

Your IRA worth $20,000 drops 30% to $14,000 due to stock market decline

You convert the IRA to a Roth IRA while it is worth $14,000. This is the amount that you will owe income taxes on.

If the market recovers 50% after the conversion, the $14,000 Roth IRA grows to $21,000.  The $7,000 of growth is all income tax free!

3.  Rebalancing – Your portfolio mix may get out of line when the market moves downward sharply.  Imagine you had a target portfolio of 50% stocks and 50% fixed income.  If the stock market drops 15% and the bond market goes up 2%, you now have an overall mix of approximately 45% stocks and 55% fixed income.

Naturally, if you were to rebalance, you would sell some of the fixed income and buy some of the stocks to get back to the 50/50 mix.  Assuming a stock market recovery, you effectively would be buying stocks low and selling fixed income high.  I’ve seen this disciplined strategy pay big dividends for investors over the long-term.

4.  Cash to Invest – I often see clients who build up large cash positions in the bank because they don’t spend all the money they earn.  As the bank account grows larger, they eventually consider investing some of their excess cash.  If you have excess cash, now would be a great time to put it to work.  While no one can predict if this recent decline will get worse before it gets better, one thing for sure is that prices are more than 10% off their recent highs. 

Most of us look for discounts when we shop for things like cars or clothes.  Unfortunately, very few people think the same way about the stock market.  It has been said many times that stocks are one of the few things people don’t want to buy on sale.  Framing the decision to invest your cash when the market is down as an opportunity will go a long way towards building your financial future.

Steven Elwell, CFP®, August 26, 2015

Learn more about my services at www.sbvfinancial.com

Retiring? 4 Reason to Delay Social Security

As you near retirement, you face many important financial decisions. How much can you afford to spend each year while making sure you don’t run out of money? When should you start taking your pension, if you get one? Which account should you pull money from first?

One of the biggest decisions is when to start drawing Social Security. According to theCenter for Retirement Research at Boston College, about 42% of men and 47% of women start taking benefits at age 62, which is the earliest you can do so. The earlier you start taking benefits, the less you’ll receive every month. The longer you wait, the larger your monthly benefit will be.

Some people don’t really have any choice and must start benefits immediately. But those who do have a choice should consider the potential benefits of waiting. Here are four reasons to think about delaying your Social Security.

1. People are living longer than ever

According to Social Security’s life expectancy calculator, the average man reaching age 62 will live to almost 84, while the average woman reaching 62 will live to 86. This means half of 62-year-olds can expect to live even longer than those ages! With continued advances in medical technology, life expectancy will probably continue to increase. This is good news for longevity — but not so good news for finances. You’ll need your money to last as long as you do. One way to help make that happen is to delay Social Security to receive a higher benefit, which can take stress off your savings. A higher benefit also means your annual cost of living adjustment (COLA) will result in more money in real terms. Here’s an example from a year with a 2% COLA:

$1,000/month benefit x 2% COLA = $20/month increase$1,800/month benefit x 2% COLA = $36/month increase

Because you’d be starting from a higher base, your benefit would increase by $432 in such a year rather than $240. The extra $192 is excellent protection against inflation.

2. Benefits grow 8% each year you wait

For each year you delay starting Social Security between 62 and 70, your monthly benefit increases by about 8%. In today’s low-interest-rate environment, it is impossible to find an 8% guaranteed return. Any investment professional worth his salt will tell you the stock market cannot guarantee that type of return every year.

As a real-life example, I have one client whose benefit amount at age 62 is $1,736 a month. If that person waits until age 70, the benefit increases to $3,259 a month. That’s an 87.7% increase — close to twice as much! Waiting till age 70 will, of course, mean missing out on eight years’ worth of benefits, but going back to my first point, if you live long enough, you will more than make up the difference. The client in the example would do so before reaching 80.

3. Big IRA/401(k) tax savings possible

Once you’ve decided to delay Social Security, the natural question is: Where do you get income while waiting for your benefits to start? Since most people in this situation will not have any other source of taxable income, this provides an amazing opportunity to take money out of an IRA or 401(k) at low or zero tax rates.

This is the grand slam of tax planning. Imagine putting money in your 401(k) to avoid a current tax rate of 25% or more, allowing it to grow for decades tax-deferred and then taking it out in retirement without owing any taxes. I’ve had clients be able to do this with proper planning, and it’s a wonderful result. If you don’t need the money immediately, consider converting it to a Roth IRA. You take advantage of low or zero tax rates, and then your money can grow tax-free from then on.

4. Spousal benefits can pay you to wait

 A big financial benefit of marriage is the ability to collect benefits based on your spouse’s Social Security record rather than your own. It can be a complicated decision, but basically you can collect a benefit equal to 50% of your spouse’s full retirement age (FRA) benefit once you hit your own full retirement age — 65 to 67, depending on when you were born. You can collect this benefit and continue to delay your own benefit until age 70, at which time you switch to your own higher monthly payment. You can claim a spousal benefit before reaching your FRA, but Social Security will only give you the higher of your own benefit or the spousal benefit, and you will lose the ability to defer your own benefit.

Divorced/widowed people eligible, too

Those who are divorced but were married longer than 10 years have a right to claim spousal benefits based on their ex’s record. (This has no effect on their ex’s benefits.) Those who are widowed are allowed to claim survivor’s benefits as early as age 60 with no effect on their own retirement benefit.

I strongly encourage anyone who is divorced or widowed to visit with an expert to help make smart claiming decisions. Social Security agents are not allowed to give advice and may not even be knowledgeable in basic claiming strategies.

Learn more about how I help retirees at www.sbvfinancial.com

*This article was originally published on NerdWallet.com