Let’s not mince our words. Bear markets are painful and can be downright scary, but they also present unique opportunities to improve your financial situation.
High inflation, historic rate hikes by the Fed and the threat of a recession can weigh heavily on an investor’s conscience. Meanwhile, uplifting news has seemed pretty hard to come by lately. The most recent core CPI reading (opens in a new tab) – which excludes food and energy – rose 6.6% year-on-year to a 40-year high, while the headline CPI hit 8.2%, recording its seventh month consecutive above 8%.
But I have a specific playbook ready in case the markets go down. For example, I know that falling stock prices make it easier to turn over expensive investments, lower my tax bill, and make more money work. (The opinions expressed are those of the author and may not be indicative of the experiences of others.)
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Here are some ways to take advantage of the opportunities available to you:
Convert a Traditional IRA to a Roth IRA
When assessing your financial situation, one of the first things to consider is long-term savings. If you currently have a traditional IRA, you might want to consider converting it to a Roth IRA. A Roth IRA requires contributions to be made in after-tax dollars, but with the resulting earnings untaxed if you maintain the account for at least five years and are 59½ or older at the time of withdrawal.
Yes, you will have to pay tax on the account balance that is transferred, but converting when the market is down means your account will likely be worth less, resulting in a lower tax bill.
Collect tax losses
Tax loss harvesting, the practice of realizing capital losses to offset capital gains, can also help reduce your tax bill. Any investment losses can be deducted from realized capital gains, while additional losses can be used to reduce your taxable income by up to $3,000, or they can be carried forward for use in subsequent tax years.
The process is relatively simple. You first sell an investment that is trading below your original purchase price. To maintain your market exposure, reinvest the sale proceeds in another security that fits your asset allocation strategy. The value of the loss you realized then becomes available to reduce taxable capital gains and potentially taxable income.
Reduce costs by opting for lower-cost investments
Although investment fees may seem small, they can have a major impact on your long-term portfolio. Take a look at your investments and see where you might be able to switch from expensive funds to funds with lower expense ratios. The tax costs of liquidating positions with large embedded gains can keep an investor in high-cost funds. When the markets are down, these costs are also reduced, providing an excellent opportunity to turn to a lower cost investment.
Over a 30-year period, going from a fund with an expense ratio of 0.47% (the average for mutual funds) to an expense ratio of 0.06% (the average for index funds) could mean about 12% more money in your account.
Get off the sideline
Many studies have shown that time in market is the biggest predictor of investment success. But even the most disciplined investor may have seen the eye-watering valuations of recent years and been hesitant to invest new cash. With valuations now coming down to earth, investors may feel a little better about deploying this dry powder.
The market and the economy fluctuate by nature, but sophisticated investors know that bear markets also present opportunities. Investors should consider using this bear market, and everything in the future, to put themselves and their portfolios on a stronger footing.
Nothing in this communication should be construed as an offer, recommendation or solicitation to buy or sell securities. In addition, investors are encouraged to consult their personal tax advisers regarding their particular circumstances.
This article was written by and presents the views of our contributing advisor, not Kiplinger’s editorial staff. You can check advisor records with the SEC (opens in a new tab) or with FINRA (opens in a new tab).
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