Ryan A. Dunn, CFP®
In 2022 Make Lemonade Out of Lemons
Updated: Oct 27, 2022
There are great opportunities to prosper in every market climate and economic cycle.
Now may be a great time to harvest losses, seek bargains, rebalance your portfolio, change your allocation or reduce concentrated stock positions.
Make sure you’re putting idle cash to work. Consider doing a Roth conversion.
As I was mowing my rapidly dying lawn over the weekend, it occurred to me it hasn’t rained in about three weeks here in Pennsylvania and New Jersey. When’s the last time Arizona got more rainfall in the summer than we did? Well, nothing’s normal in 2022, so why should the weather be any different? At times like these, when there are so many headwinds facing us on the economic, financial, and geopolitical front, I wanted to share with you six key strategies for benefitting from down markets. If you’re a Novi client, we’re already doing these for you. You just may not realize it.
1. Tax-loss harvesting. Selling securities at a loss and buying similar security allows you to use losses from underperforming investments to offset taxable gains from other investments. In a widespread bear market like today, now is an excellent time to do tax-loss harvesting. For example, if you invested $10,000 in an S&P 500 index fund a year ago, that fund is probably worth less than $8,000 today. You can sell that fund now for a $2,000 loss and use the remaining $8,000 to buy a similar index fund (say Russell 3000). This preserves your diversification plan but allows you to use the $2,000 loss to offset $2,000 in long-term gains at the end of the year. The same goes for underperforming bonds which are having their worst year in four decades. If you don’t have any gains to offset, you’re allowed to use up to $3,000 a year in capital losses to offset your ordinary income. This is especially helpful for people in high-income brackets.
2. Rebalancing. When the opportunity arises, we sell asset classes that are doing well and buy asset classes that are not performing well in the short term. It may sound counterintuitive, but it’s the good old-fashioned buy-low/sell-high strategy.
For instance, if bonds start to stabilize in the second half of this year and stocks continue to slide, we’ll start selling bonds that are doing well and buying into good stocks that are currently undervalued. For example, emerging market stocks were getting crushed during the financial crisis of 2009 to the tune of minus 50%. But we took advantage of those depressed prices for our clients and bought in. The following year emerging market stocks returned over 75%. We know that over long periods of time, all asset classes are going to recover. We want to make sure you are participating in those areas that are trading at a discount.
3. Investing cash that has been sitting on the sidelines. If you’re sitting on lots of cash in a savings account that’s earning essentially no interest, now is a great time to get that money working for you at discounted prices. For clients who are still saving for retirement, you’ll want to make sure you have three to six months of cash available for emergency purposes. For clients that are currently drawing from their portfolio, we ensure that you will have three months of cash available to get you through your short-term needs. After that consider, putting your remaining idle cash to work to supplement existing areas of your portfolio. You may also want to consider inflation-protected Series I bonds. Without taking these steps, however, your excess cash is just sitting idle and being eaten away by inflation.
4. Roth conversions. IRA values are down, but that’s not necessarily a bad thing. If your income is going to be lower than normal this year due to job loss, early retirement or other circumstances it’s a great time to do a Roth conversion. That’s because your tax rate on your IRA gains will be lower. The markets will eventually bounce back. It’s much better to get that growth in a Roth IRA, which can be distributed tax-free, than to keep it in an IRA that will eventually need to be distributed and taxed as income. For more about Roth conversions, see my colleague Ryan Vogel’s post Is Now the Time to Do a Roth Conversion?
5. Changing allocation. For those of you considering taking more risk today, now is a great time to change your allocation to a slightly more aggressive portfolio. Say from 50/50 stocks-to-bonds to 60/40. The stock market will eventually recover and when it does, the rebound will likely be greater than it is for bonds and most other asset classes. Positioning yourself for that rebound usually pays off in the long run if you’re willing to endure some volatility today.
6. Reducing concentrated positions. If your longtime holdings of Apple, JNJ or your employer’s stock represents a significant percentage of your overall portfolio, now may be an excellent time to get some diversification while reducing the tax burden of doing so. That’s because the value of these stocks is temporarily down due to the bear market. Selling some of that stock today will mean your capital gains (and in turn, taxes) will not be as high as they would have been last year – or when the market inevitably rebounds. And chances are, you can use some of your losses harvested from Strategy #1 above to offset those gains.
While these strategies above might not be appropriate for each of our clients, it’s something we are constantly reviewing for everyone one of you. When life gives you lemons, make lemonade!
Conclusion If you or someone close to you has concerns about your portfolio, asset allocation or tax situation, don’t hesitate to reach out. We’ve helped many clients like you in similar situations.
RYAN A. DUNN, CFP®, is a Wealth Manager at Novi Wealth