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Financial Planning in a Down Market

Bear markets can create difficult situations for many individuals. While a down market can disrupt original financial plans, they can also open up additional planning opportunities.

Below are various planning techniques that may be appropriate during a down market:

  • Roth Conversions – A Roth conversion involves transferring qualified, pre-tax assets, such as an IRA or 401(k), to a Roth account. As a result, the owner of the account pays tax immediately on the entire value of the transfer. This allows for tax-free distributions at a future date. Bear markets can make this strategy much less costly for investors due to the fact that the pre-tax account value has decreased. Thus, one is transferring a lower amount which results in lower taxes, as well as providing the opportunity for tax-free growth when the asset recovers from the decline. If an individual was already thinking about a Roth conversion, a down market is the perfect time to evaluate this strategy.
  • Tax-Loss Harvesting – Falling asset values are usually not beneficial. However, they do create the opportunity to realize losses on assets that can offset later gains and income. This strategy is called tax-loss harvesting. Essentially, if one sells an asset where the value has fallen below the price it was bought for, the investor will have a realized capital loss. They can then take the sale proceeds and invest in other assets that may increase in value once the down market has turned around. This keeps the investor exposed to the market while still being able to offset future gains with the loss. However, an investor must keep in mind the “wash sale” rules, which would disallow a loss from an asset if a similar asset is purchased within 30 days of the sale. Investors should keep in mind that only up to $3,000 of a loss can be used to offset ordinary income. The remaining loss can be carried over to future tax returns if it is not utilized.
  • Reduce Concentrated Position – If a portfolio is highly concentrated in one asset or asset class, a down market may be a good time to move out of this position and diversify. Having a concentrated position while the market is facing difficulties may add unnecessary risk, so being able to diversify as soon as possible may reduce potential losses. If assets that need to be sold have already dropped in value, the investor may be able to recognize losses to offset future gains or income. They can also use the proceeds to diversify at a cheaper cost (tax-loss harvesting strategy). However, the investor should watch out for potential gains above their cost basis. Even though the asset may be falling during the bear market, it could still have a gain from the time it was purchased. Selling large amounts of the asset may create an unnecessary tax bill.
  • Increase Retirement Plan Contributions – Increasing retirement contributions while the market is down may seem counter intuitive, but if an investor has excess funds it can be very beneficial. Increasing contributions while assets are down allows an individual to purchase more shares of the asset. Thus, they are investing at a cheaper cost. If one typically waits to contribute to their IRA until the end of the year, it may make more sense to make the contribution while the bear market is ongoing so they can purchase investments at a lower price.
  • Refinancing Loans – Usually bear markets result in very low interest rates. Therefore, it may be a good opportunity to refinance outstanding loans or mortgages. Refinancing can result in lower monthly payments or the loan being paid off at an earlier date. Capitalizing off of low interest rates in a bear market may be very beneficial long-term.

There are many other issues and opportunities to consider, in addition to those listed above. We recommend that you speak with a Hefren-Tillotson financial advisor to ensure you are making the most informed decisions possible. Please contact Hefren-Tillotson for further details.

DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firms judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.

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