As we move into the final month of Q2 2022, it’s no secret that the financial markets, which rose fairly steadily after the “pandemic drop” in 2020, have been in a downward trend. Since January 1, the Nasdaq has been down as much as 14.5%, and the S&P 500 was off its year-beginning levels by as much as 18.6%, within a whisker of bear market territory.
We should also know by now that markets tend to go up more often than they go down, and though nobody enjoys the valleys, they can present opportunities for greater benefits during the following peaks. This volatility is the price investors pay for better long-term returns on equities. In the spirit of “making lemonade out of lemons,” here are five ways you may be able to take advantage of the current down markets to improve your position for future rising cycles.
1. Tax-loss harvesting
You’ve probably heard this before, but it bears repeating. Sometimes, taking a loss on paper is a smart way to pay fewer taxes on future gains. In a down market, you’re likely to have some investments that are temporarily in the red. By recognizing that loss, you can free up funds to make strategic purchases—including assets similar to the one you sold, as long as you carefully follow the wash-sale rules—repositioning yourself for future growth with the added advantage of a loss that can reduce a future capital gains tax bill. You may even be able to use some of the loss to offset taxes on current ordinary income.
2. Roths for kids
Funding a Roth IRA for the next generation is a great strategy for teaching the magic of tax-free compounding and growth as well as instilling the habit of building wealth for the future. So, why not do it now, while assets for long-term growth are attractively priced? Historical data shows that S&P 500 returns after 8 troughs in consumer sentiment since 1971 have averaged 24.9%. We are currently in such a trough.
3. Deploy excess cash
It has often been said that the financial markets are the only store where the customers head for the exits when everything goes on sale. But as Warren Buffett has wisely observed, the time to be fearful is when others are greedy, and the time to be greedy is when others are fearful (i.e., when consumer sentiment is in a trough). Depending on your time horizon and your short-term needs, you may have excess cash available for investment. If you do, the best time to put it to work may be while the market is down—when attractive investments are “sale-priced.”
4. Consider a Roth conversion
Utilizing the same principle, it may make sense to convert a traditional IRA or 401K account to a Roth account while the assets in the account are at a lower valuation. Remember that when you convert to a Roth account, you pay taxes on any pre-tax contributions to the traditional account. Since the value of the account is likely down due to market action, you may be able to pay taxes on a lower amount. Then, in later years, when the market has likely recovered and you’re ready to start making withdrawals, they’ll be tax-free.
5. Wealth-transfer trusts
For those concerned about potential estate tax liability, it can make sense to transfer assets while values are depressed. Not only are you moving the assets into a place of greater protection from creditors and spendthrift heirs, but you’re also moving the future appreciation. Even for those who aren’t in great danger of incurring wealth transfer taxes, placing into trust assets with high appreciation potential is a great way to leverage higher growth for the beneficiaries of the trust.
At JFS Wealth Advisors, we deploy our experience, expertise, and evidence-based market research to guide clients through all kinds of markets—up, down, or sideways. Our fiduciary commitment to putting our clients’ best interests ahead of everything else means that we are there for you, from beginning to end.