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
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