Even if you’re not dependent on your investment portfolio, losing money (even if only temporary) is never fun. Fortunately, there are strategies you can take advantage of to lessen the impact of a bear market and *hopefully* set yourself up for success when markets rebound.
Although no one knows when markets will rebound, now is the time to fight panic and be proactive with planning.
Here are three strategies you can take advantage of during a bear market:
When investments in a taxable account drop in value, “harvesting the losses” is a great strategy for lessening the impact of these losses.
Any losses harvested can be used to offset gains that have been realized (in that tax year), effectively reducing taxes owed. If you have no capital gains to offset, you can use up to $3,000 of loss to reduce your taxable income, or $1,500 each if married filing separately. However, the additional tax loss may be carried forward for use on future tax returns.
One of the key things to be aware of with tax-loss harvesting is to make sure you avoid the “wash-sale rule”. The IRS won’t let you buy an asset and sell it solely for the purpose of paying less taxes. The loss will be disallowed if the same or a substantially identical asset is purchased within 30 days.
It’s important that you get back invested right away after taking advantage of tax-loss harvesting (so that you don’t miss out on potential rallies).
You want to make sure you avoid the wash-sale rule when buying a stock, mutual fund, ETF, etc. to replace the security you’ve sold to take advantage of the loss.
Luckily, there are plenty of options that are considered “substantially different” but still allow you to maintain your risk profile.
If you’re interested in learning more, here is an article from Investopedia on How to Use Tax-Loss Harvesting to Improve Your Returns.
This only works if you have a defined investment strategy ahead of time. If you’ve done a financial planning analysis and determined how much risk you can afford (and/or is needed) in your portfolio to achieve your financial goals, now is the time to remain disciplined to that risk profile.
Even for the investor with a long time horizon (20 + years), it’s unlikely you would have 100% of your investment portfolio in stocks. If you had built in some kind of diversification into your portfolio, by owning other assets such as bonds, treasuries, and commodities, there should be room to rebalance back to your original risk profile.
The best way to rebalance is to have rules built in ahead of time. By having rules in place for when a rebalancing event is triggered, it removes the emotion from the decision making progress when you’re trying to determine “the right time to buy stocks”.
The time when it feels the most painful to rebalance back into owning more stocks is *usually” the best time to do so. While there is always the risk of increases in short-term decline, your future self should be rewarded for remaining disciplined to the risk profile that is appropriate based on your current financial situation.
It’s important to avoid “all-in” or “all-out” strategies. We don’t know the sequence of returns and we definitely don’t know when markets will bottom and rebound. The most important thing is to remain disciplined to your pre-determined risk profile to benefit once markets inevitably rally.
Planning for tax diversification is essential to any financial plan. Regardless of market environments, you should want to plan for flexibility in retirement to be able to pull from pre-tax and after-tax accounts depending on where tax brackets are at that time. That way, you’re not *totally* beholden to the unknown fiscal policy that awaits us.
If you’ve been looking to take advantage of Roth conversions to shift pre-tax money to after-tax accounts, now would a great time to consider converting securities that have declined in value.
By doing so, you’re putting yourself in a position to potentially benefit from substantial growth once markets rally. As a reminder, any money (or securities) converted to a Roth IRA will never be taxed again (after the conversion amount has been paid).
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Imagine investing 96% of your free cash flow into an individual stock before establishing any kind of cash reserve.
— T.J. van Gerven (@TJvanGerven) March 17, 2020