6 Strategies to Maximize Wealth During Periods of Market Uncertainty
Historically, staying on course and on plan has outperformed panicked investment decisions (such as cashing out) through bouts of stock market uncertainty. But staying on course doesn’t necessarily mean standing pat.
With headlines of inflation, interest rates and a Russia invasion, there’s been considerable talk about market volatility lately. But instead of focusing on things outside of our control, below are several strategies we employ with our clients to potentially take advantage of planning opportunities that may be uniquely present amid volatility.
Strategy #1 – Opportunistic Rebalancing
Rebalancing is the process of realigning a portfolio’s blend of assets back to a target allocation when it drifts out of balance due to market movements — in other words, selling investments that have maintained value or outperformed and reinvesting proceeds into underperforming vehicles. Periodically rebalancing your portfolio, especially during market pullbacks, allows investors to follow the adage “buy low, sell high.”
For example, let’s say your portfolio is composed of 60% stocks and 40% bonds. If stock prices drop 20% across the board, your portfolio weighting would naturally drift to 55% stocks and 45% bonds. Using an opportunistic rebalancing strategy, a portion of your bond allocation can be sold to purchase stocks, increasing your stock percentage back to the 60% target.
Strategy #2 – Tax-Loss Harvesting
Tax harvesting can also be implemented through market volatility, often while rebalancing a portfolio as a whole. If securities in a taxable investment account have dropped below the original purchase price, they can be sold to harvest the tax loss. The loss is essentially set aside and used in the future to offset gains and reduce your overall tax bill. You can use up to $3,000 in losses to offset ordinary income, and unused losses will carry forward to offset gains in future tax years.
Once sold, immediately purchase a similar investment to participate in the eventual recovery. In essence, investors have the opportunity to maintain market exposure while also capitalizing on downturns by booking losses to reduce taxes. However, be careful not to purchase the exact same, or a “substantially identical,” investment within 30 days of placing the original sale, otherwise the IRS will disallow the loss.
Strategy #3 – Increasing Savings
For whatever reason (and counterintuitive to the lines seen around stores on black Friday), stocks are often the one item people don’t like to purchase when on sale! Investors who are still saving or have idle cash may be thankful for market corrections, as it allows the opportunity to effectively go bargain hunting. Purchasing securities at a decreased share price allows investors to acquire more shares with the same amount of funds, thus potentially increasing returns over time.
For those still in earning years who are contributing to employer retirement plans, market pullbacks may be a blessing in disguise as well. By contributing to your employer retirement plan, such as your 401(k), 403(b), etc., you’re effectively buying market dips on a regular basis through paycheck deferrals. In fact, assuming cash flow permits, you can expand on this strategy to further take advantage of volatility. For those that have some wiggle room in your monthly budget, consider deferring a larger percentage of your paycheck to your employer plan during bouts of volatility. If you’re considering doing so, see if your plan has a true-up provision or work with a wealth manager to ensure you’re not missing out on the full extent of your employer match.
Strategy #4 – Roth Conversion
If initiating a Roth conversion makes sense for your overall planning strategy, you may want to consider executing it during a period of market volatility.
A Roth conversion is the process of converting a traditional IRA (pre-tax dollars) to a Roth IRA (after-tax dollars). Completing a Roth conversion requires you to pay taxes on the traditional IRA dollars in the year the conversion takes place. However, when you withdraw money from the Roth account during retirement, those funds are tax exempt (assuming you’ve reached age 59 ½).
Completing a Roth conversion during a down market allows the benefit of converting a greater percentage of your overall account from pre-tax dollars to after-tax dollars, without incurring a larger tax bill.
For example, suppose your traditional IRA was worth $1 million on January 1. If you’re targeting a $100,000 income number for your conversion, this would represent 10% of your IRA in a static market. Following a market downturn, perhaps the same IRA has decreased by 20% to $800,000. The same $100,000 income target for a Roth conversion now represents 12.5% of the account instead. As the market eventually recovers, converting a greater percentage of your portfolio will not only lessen your required minimum distribution (RMD) obligations in the future but it will also give you a greater base in your Roth to grow tax free.
Again, it’s important to make sure this strategy makes sense given your overall financial situation. In addition, there are stipulations on when Roth conversions can be distributed without losing their tax-free earnings. So be sure to consult with your wealth manager before initiating a Roth conversion.
Strategy #5 – Distributions
If you’re currently drawing on your investments for retirement income, it may make sense to adjust your distribution strategy during periods of market volatility. For example, if you’re drawing pro rata from your investment accounts, you may be selling out of equities at a loss during a downturn. It may make sense to withdraw from fixed-income sources until the market rebounds.
At Creative Planning, we typically advise clients to maintain enough conservative assets to cover five years of monthly expenses and any anticipated major purchases (college expenses, weddings, a new car, etc.). This strategy can also help you avoid having to sell equities during a market downturn.
For investors who have reached RMD age but do not need the cash flow, market pullbacks may provide distribution planning opportunities as well. Request a distribution of securities in-kind from your IRA to be transferred to your after-tax investment account to satisfy your RMD. By selecting securities that have been affected by volatility, you can effectively transfer a great number of shares out of your IRA to lessen future RMD and tax obligations without increasing your current year tax bill.
Strategy #6 – Gifting
In a similar vein to distribution planning, volatility may be an opportune time to gift to family as well. In 2022, the IRS increased annual gift-tax exclusions to $16,000 per person. In other words, an individual can gift $16,000 to anyone of their choosing without any reporting requirements or tax implications. Taken further, a married couple can gift $32,000 to their child. Or, if the child is married, $64,000 can be gifted from a set of parents. Market corrections can provide the opportunity to maximize this annual gift to a greater extent. Selecting stock that has gone down in share price will allow gifting a greater number of shares while staying below the $16,000 annual limit. And when the market eventually recovers, the recipient of the gift can be the benefactor. In the long run, this may also help lessen potential estate taxes for those over lifetime exemption amounts.
As with most financial challenges, we believe the best strategy is to have a plan in place to help navigate the challenges of a volatile market. If you’d like assistance implementing any of these planning strategies across various market cycles, or help with any other financial matter, please schedule a call with a member of our team.