With the stock market in the midst of a series of stomach-churning dips, investors may be tempted to run for the exits. Instead, consider how you might take advantage of the downturn, financial advisors say.
The S&P 500 has lost about 22% for the year amid widespread pessimism. Interest rates are rising, inflation has proven persistent, and geopolitical tensions are running high. It’s understandable to feel rattled. “The hard thing right now with this market correction is there’s nowhere to hide; even bonds are down,” said Beth Handwerker, a certified financial planner with James Investment in Beavercreek, Ohio.
Remember that markets are cyclical, and downturns are to be expected. “The bull markets are always followed by a cyclical bear market—it’s like feast and famine,” said Barry Bannister, Stifel’s chief equity strategist.
While it’s painful to see your accounts in the red, your losses only become real when you sell out of your positions. Until then, it’s just a loss on paper. You might want to do some strategic selling, but for the most part you’re going to want to wait to give your assets time to recover. Though it might seem like the safest move at the time, pulling your money out of stocks will only hamper your ability to build wealth over the long term.
Here are some strategies to consider, no matter where you are in your investing journey:
Double Down on Your Goals
If you’re saving for retirement, consider saving even more, since stocks are on sale. “This is a great time to make your IRA contribution,” Handwerker said. If you’re saving in a 401(k), increase your contribution rate.
For retirees, it’s time to take a strategic approach to your portfolio withdrawals. If you have multiple tax-deferred individual retirement accounts that are subject to required minimum distributions (RMD), you don’t have to take that sum from each one. You do have to calculate your RMD for each account separately, but then you have the option to aggregate the total and withdraw it from whichever IRA you want. So if you have a larger cash position in one account, you can withdraw your RMD from there to leave the stocks alone to give them time to recover, Handwerker said.
With accounts that don’t receive preferential tax treatment, such as your taxable brokerage account, consider selling a losing position (a position that is worth less than what you paid for it) and realizing a tax loss. If you need cash to live on, better to take it from a nonqualified account and take a loss on your income taxes, than from an IRA and owe ordinary income tax on it, Handwerker said.
Consider a Roth Conversion
Until the time comes, many retirees don’t appreciate the extent to which Uncle Sam takes a bite out of their tax-deferred retirement accounts. A large balance in tax-deferred accounts means larger RMDs than you might otherwise want, which results in higher taxable income and higher income-adjusted Medicare premiums. To help avoid this scenario, it’s good to have some post-tax money in retirement, which you’ve already paid taxes on and can withdraw tax-free.
Roth IRAs are post-tax accounts that offer flexibility for savers. (You can withdraw your contributions at any time, tax and penalty-free.) There are income limits for contributing to a Roth IRA, but there are no income limits for making a Roth conversion. Roth IRAs aren’t subject to RMDs while the original owner is alive.
When you convert your traditional IRA to a Roth, you’ll owe income taxes on the full amount converted. That’s why it’s a good idea to do a conversion when the market is down: you’ll be transferring a smaller balance, so you’ll owe less in taxes.
You don’t have to transfer the whole amount, either. You can open a Roth and convert just enough to keep you in your current tax bracket instead of bumping you up into a higher one. The income thresholds for Medicare premiums are different from federal income tax brackets, so if you’re on Medicare you’ll want to keep an eye on those too.
Make sure you have outside funds to pay the taxes on the conversion; you don’t want to have to pay them from within the account, since that will undo some of the benefit of the conversion.
Expand Your Cash Cushion
Now’s not the time to have lazy cash lying around a low-yielding bank or brokerage account. Yields have finally crept up on safe instruments, so make sure to put your cash to work. Online-only savings accounts are offering around 2% these days. Certificates of deposit offer competitive rates too, but they’re less liquid, so consider when you might need to access the money.
Many financial advisors recommend keeping between three and six months’ worth of expenses in a liquid emergency fund. With a possible recession looming, it might be time to up your allocation, if possible. Those with very stable jobs may be fine weathering an economic downturn with the lower end of the range, but those with more volatile situations should aim for at least six months’ of expenses in liquid savings, Handwerker said.
A healthy cash cushion will help you cope with a job loss or other emergency without taking on credit card debt or raiding your retirement account to pay your bills.
This article was originally published in Barron’s on September 27, 2022, and written by Elizabeth O’Brien.
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