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Smart money moves in bear market

On September 30th, the S&P 500 closed at 3585.62 – down 23% year to date. The bears are here, and we have no idea how long it will be before the bulls return. While looking at retirement or brokerage account statements may not be the most gratifying experience these days like it was in 2021, there are five smart money moves investors can do to take advantage of the drop in asset prices:

  • Tax-loss harvest
  • Rebalance
  • Continue contributing to retirement accounts
  • Roth Conversion
  • Dollar Cost Average

Tax-Loss Harvest

The current market presents an opportunity to sell depreciated assets and use the loss to offset the capital gains taxes on assets that have appreciated since. This is particularly effective in offsetting gains on equities that you own at a low cost basis or have held for some time. And given the long bull market and the performance last year – you probably still have some winners in your account.

Even if you don’t have gains to offset, tax-loss harvesting can still make sense. You can use up to $3,000 of losses to offset your current ordinary income in the current tax year. And you can carry the excess loss forward, offsetting up to $3,000 of ordinary income in subsequent years until the entire amount of the carry over loss is exhausted.

Rebalance Your Portfolio

Review your short- and long-term goals to be sure that your investment plan doesn’t need tweaking. Based on your risk tolerance, objective, and time line, you should have target asset allocation that can carry you through any storm. Once you’ve determined the right strategy, you can sell assets to nudge your portfolio back in line with your preferred risk parameters and market views. Adding diversification can help to cushion your portfolio, and there may be assets that represent better value or growth potential now that prices have declined.

Don’t Neglect tax-deferred Savings

Investing when asset prices are lower makes sense, particularly if you have a long-term perspective. Investing into a down market (that may go lower) doesn’t feel great, but comparatively, stocks are “on sale” from recent highs, and we know from history that the market does go higher over time.

The advantage of contributing towards a tax-advantaged account is to lower your taxes during your working years. Investing in your 401(k) account, Health Savings Account (HSA), and if applicable, a 529 Plan for education savings (for potential state tax benefits) are ways to lower your tax burden now, as well as position your portfolio to benefit from a recovery.

The Roth Conversion Is More Attractive

Retirement tax planning is critical to keeping as much of your income as possible. You not only want to stay in lower tax brackets, but you also want to avoid having an income level that will result in taxes on social security or a sudden jump to the IRMAA surcharge on Medicare Part B and Part D premiums.

Tax-deferred retirement savings are important in your accumulation years, as they lower taxable income. But you reverse the process when you make withdrawals in retirement. And starting at age 72, required minimum distributions (RMDs) will limit your income flexibility.

One solution is a Roth conversion, in which you withdraw from your tax-deferred account, pay the tax and invest in a Roth account. There are no income limits on conversions, but the withdrawals are taxed as ordinary income. Lower asset prices mean you’re paying less in taxes. As asset prices recover, growth will be tax-deferred, and future withdrawals will be tax-free. And because you’ve already paid the tax, RMDs are not imposed on the converted amount.

Dollar cost average into the market

Continue investing whether market prices are high or low. Dollar cost averaging (DCA) is a time-tested strategy that helps you buy more when prices are low and less when the prices are high.

Settle on a fixed dollar amount you can afford to invest monthly. Then, take the same dollar amount and spread it evenly across your investments. For example, say you decided on investing $10 monthly. And you owned 2 positions: Stock A with a price per share of $5 and Stock B with a price per share of $2.50. When the market goes up, you will buy less of stock A and B, but when the market goes down, you buy more. At times you might see A up and B down in which case, you would buy more of B and less of A. At the end of the day, you should end up with a lower average stock price compared to the initial price of the stocks.

The Bottom Line

After a long bull market, getting used to the new reality of volatility and lower asset prices can be difficult. But changing your perspective to proactively look for ways to make the most of this bear market can help you ride out the discomfort more effectively and help keep your plan on track.