Make a Down Market Work For You

Okay, so your investment value took a hit in the recent market plummet. With a bull market that extended over ten years, hopefully this wasn’t a total surprise. I’m not sure anyone thought it would drop 30%, and no one knew of the exact timing, but if you followed our blog and looked to market history for indications and insights of what was to come, a market correction of some type was not off your radar. Hopefully you had a financial plan that considered this and were comfortable with your risk tolerance and any unrealized losses that you incurred.

 

Now that your portfolio is down, what can you do? While nothing is a blanket statement that can be applied to everyone, there are some strategies you can consider. Be sure to speak with your advisor to see if either of these tactics could work for you.

 

1. Roth Conversion:

 

Many people contribute to a traditional IRA or a traditional 401(k). The way these registrations are structured provides for contributions to a retirement investment vehicle that allows for tax benefits in the year of contribution. When the funds are drawn on, they are fully taxable. The alternative is a ROTH account. There are a few differences between Roth accounts and traditional, but the biggest difference is their tax treatment. Roth accounts provide no immediate tax benefit, but all growth and principal are tax free to the investor when they withdraw their money. There are some restrictions, like needing to be over 59 ½ to avoid a penalty, but that’s the basic idea.

 

Tax free growth and income in retirement is enticing. If you have contributed to a traditional IRA or 401(k), you’ve already received a tax benefit. It may make sense to undo this, and do what’s called a Roth conversion. You would be taxed now, but with benefits later. How does this work? Essentially you take all or some of your traditional account, and tax yourself on that withdrawal as if it were income. You’d then place it in a newly opened Roth account, allowing for the account to have tax free growth and provide a tax free income source in retirement.

 

Why is now the time to do this? Well, two reasons. One is, if you’re like many, you may have had your hours and pay reduced this year with the coronavirus outbreak. Talk with your CPA, but this may mean you’ll be in a lower tax bracket this year. If that’s the case, you would have received a higher tax benefit when your originally contributed to your traditional account than the tax you’ll pay during Roth conversion this year. That’s a perfect tax strategy. Secondly, by doing the conversion while the value of your portfolio is lower, the amount that you are taxed on is lower. That’s a double benefit… lower amount taxable at a lower tax rate.

 

Of course, you’ll need to be able to pay tax on this “phantom” income at the end of the year, but if you have the cash flow to do so, you could be in a much better position. Talk to your advisor and CPA to see if this move is right for you, and if it is, how much of your portfolio you should consider converting.

 

2. The next strategy is just to consider buying more funds.

The market is down. While no one has a crystal ball, it more likely than not will go back up if historic performance is any indication of the future outlook. The market will probably stay volatile for a while, with highs and lows and unpredictability. That said, if you can stomach that, it’s almost like everything is on sale right now. Why not take advantage? Be sure to speak with your advisor to see if this strategy aligns with your risk tolerance, goals, and timelines. It’s not a strategy for everyone, but for some, it could be a great move.

 

No one wants a down market. When they happen, though, it’s important to make the right decisions. What you do now with your finances during these trying times can have a lasting impact on your future. Don’t make rash decisions. If you’re looking for guidance, we are here to help.