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6 Ways to Maximize Wealth During Market Volatility
September 30, 2022
Through periods of stock market turbulence, keeping on track and following the plan has historically outperformed making impulsive investment judgments like cashing out. But sticking on course doesn’t always entail doing nothing.
There has been a lot of discussion of market volatility recently, along with headlines on inflation, recession, higher interest rates and other global economic issues. But rather than dwelling on issues that are beyond your control, you may use the following strategies to take advantage of planning opportunities that could be uniquely present during volatility.
Strategy No. 1 – Opportunistic Rebalancing
When a portfolio shifts out of balance resulting from market fluctuations, rebalancing is the process of restructuring the mix of assets to the target allocation. To do this, you would sell investments that have held their value or outperformed the market and reinvest the proceeds in poorly performing assets. Investors may adhere to the maxim “buy low, sell high” by routinely rebalancing their portfolios, especially during market downturns.
Consider an example of a strategy where you and your financial planner have established that your portfolio shall be made up of 70% equities and 30% fixed assets. If all equity asset prices fell by 10%, your portfolio’s allocation could probably shift to about 60% equities and 40 % fixed. You may raise your equity allocation back to the desired 70 % by using an opportunistic rebalancing method, which involves selling some of your fixed allocation and buying more equities.
Strategy No. 2 – Harvesting Tax Losses
Market volatility can also be used to perform tax-loss harvesting, frequently in conjunction with portfolio rebalancing. Securities in taxable investment accounts may be sold to realize a tax loss if their value has fallen below the price at which they were initially purchased. In essence, the loss is saved and will be used later to offset profits and lower your overall tax burden. Ordinary income can be reduced by up to $3,000 in losses, and any losses that are not utilized can be carried forward to reduce profits in subsequent tax years.
As soon as you sell, buy a comparable investment to take part in the eventual rebound. In general, investors have the opportunity to keep exposure to the market while simultaneously profiting from downturns by recording losses to lower taxes. To avoid the IRS from disallowing the loss, be cautious not to buy the exact same investment or one that is “substantially identical” within 30 days of making the initial transaction.
Strategy No. 3 – Increasing Savings
Stocks are frequently the one item consumers don’t want to buy while on sale, for whatever reason! Market corrections may be welcomed by investors who are still saving or who have extra cash on hand since they provide them the chance to go bargain shopping. Investors can buy more shares with the same amount of money by purchasing assets at a lower share price, thereby improving profits over time.
Market pullbacks might also be a gift in disguise for people who are still in their earning years and are making contributions to workplace retirement plans. By making monthly payroll deferrals to your employer’s retirement plan, such as your 401(k), 403(b), etc., you’re essentially purchasing market declines. In fact, if cash flow allows, you may build on this approach to further profit from volatility. If your monthly budget allows it, you might want to think about contributing more of your income to your employer’s retirement plan when things are turbulent. Whether you’re thinking about doing this, check to see if your plan includes a true-up clause or consult a wealth manager to be sure you’re not losing out on the entire employer match.
Strategy No. 4 – Roth Conversion
You might wish to think about carrying out a Roth conversion during a period of market turbulence if doing so makes sense for your overall planning approach.
The process of converting a traditional IRA (which uses pre-tax funds) to a Roth IRA (after-tax funds) is known as a Roth conversion. You must pay taxes on the traditional IRA funds in the year of the conversion if you complete a Roth conversion. Furthermore, those savings are tax-free when you take money from the Roth account in retirement (presuming you’ve reached age 59 1/2).
By executing a Roth conversion during a market downturn, you can increase the percentage of your total account that is converted from pre-tax to after-tax funds without increasing your tax liability.
Consider your traditional IRA as having a $1 million value on January 1st. If you want to convert at a $100,000 income level, 10% of your IRA would be represented by that amount in a static market. After a market downturn, the same IRA may have dropped by 20% to $800,000. The account now represents 12.5% of the same $100,000 income threshold for a Roth conversion. Converting a larger portion of your portfolio once the market finally recovers would not only reduce your required minimum distribution (RMD) responsibilities in the future, but it would also offer you a lower basis for your Roth to grow tax-free.
Yet again, it’s crucial to confirm that this plan makes sense in light of your total financial circumstances. Furthermore, there are restrictions on when distributions from Roth conversions can be made without losing their tax-free gains. Roth IRAs can also sometimes do more harm than good if you reside in another country. Therefore, before beginning a Roth conversion strategy, be sure to speak with your cross border financial planner to see if it makes sense based on your current country of residence and plans for retirement
Strategy No. 5 – Distributions
When the markets are volatile, it can be a good idea to modify your distribution plan especially if you are presently relying on your investments for retirement income. For instance, if you are taking pro rata withdrawals from your investment accounts, you can be selling off your stock portfolio during a downturn at a loss. It could be prudent to start cherry picking by taking income distributions from other parts of your portfolio that are performing well assuming you have a well diversified portfolio to pick from until such a time that equities rebound.
Market pullbacks may also present distribution planning opportunities for investors who have already entered RMD (Required Minimum Distribution) age (72) within their qualified plan but do not need the cash flow. To fulfill your RMD, ask for a distribution of assets in-kind from your IRA to be moved to your after-tax investing account. You can efficiently transfer a larger amount of equity shares out of your IRA portfolio to reduce future RMD and tax payments without raising your current year tax liability by choosing assets that have been impacted by volatility and essentially convert what would have potentially been an ordinary income distribution to capital gains should the market bounce back later.
Strategy No. 6 – Gifting
Similar to distribution planning, volatility could also be a good time to gift to family. The IRS raised the per-person yearly gift-tax exclusion to $16,000 in 2022. This entails that a person is free to gift $16,000 to anybody they desire without needing to record or worry about its tax implications. If this is taken further, a married couple can give their child $32,000 or, $64,000 might be given as a gift from a pair of parents if the child is married. Market corrections may offer the chance to more fully leverage this gift each year. If you choose a stock which share price has dropped, you can give away more shares while still keeping within the $16,000 yearly cap. The gift receiver may also become the beneficiary when the market finally rebounds. Long-term, this may also aid people who might otherwise have estate taxes due to exceeding lifetime exemption amounts.
Disclaimer:
- The information provided is for educational purposes only and does not constitute personal financial, tax or investment advice and should not be relied on as such. It does not take into consideration any investor’s particular investment objectives, strategies, time horizon, and tax or legal status. Abacus Wealth International (AWI) does not provide tax or legal advice. Please consult a tax or legal professional for corresponding tax and legal advice.
- All material and content have been obtained from sources believed to be reliable. AWI does not guarantee the accuracy of the information provided and shall not be held liable for decisions based on the foregoing information.
- All examples of graphs, financial products and historical returns contained in the foregoing material are for illustration and educational purposes only and shall not be deemed as financial advice or recommendation. Past performance is not indicative of any future investment returns.