Volatility and risk are part of the stock market experience – it’s why stocks produce higher returns than less-risky assets over long periods of time. We say this often, it’s easy to forget when the market declines.
A virus spreading around the globe, OPEC infighting, and interest rates falling can all feel like valid reasons to run for the hills. But our need to act can lead to more harm than good for your portfolio.
The good news about a down market and lower interest rates is there are meaningful financial planning opportunities. As you review your plan in the context of the current market environment consider whether any of the following present opportunities to take advantage of the current situation.
1. Rebalance Your Portfolio
We review client portfolios at least once every four weeks to check them against the agreed upon mix of stocks and bonds from your Investment Policy Statement. Based on the performance of the market, your portfolio may become riskier (stocks rise) or less risky (stocks decline) over time.
It’s quite possible you sold stocks in the past few years because they had done quite well until recently. Now it’s time to consider the opposite. Rebalancing in a down market by purchasing more stocks (at cheaper prices!) can allow your portfolio to appreciate more quickly during a market recovery.
2. Tax Loss Harvesting
When you sell an investment for less than it’s purchase price the resulting capital loss can be used to offset other capital gains. This works particularly well when you have already realized (or expect to realize) a capital gain in the same tax year and can benefit from immediate tax savings.
If your realized capital losses exceed current year capital gains, you can use $3,000 of the excess to offset ordinary income and then carry over the rest to future tax years.
3. Investing Excess Cash
We are big fans of a well-funded emergency fund, but this might be an opportunity to invest some of that cash that you won’t need for at least five years towards longer-term goals. For example, if you are retired and have 24 months of living expenses plus other known expenses (new car, upcoming trip, your child’s wedding, etc) covered, it’s probably safe to invest any excess cash in your accounts.
If you are still working and have more than 12 months of expenses saved in an emergency fund, now might be a reasonable time to invest some of that cash.
4. Refinance your mortgage
Mortgage rates are back at historic lows. If you still have a mortgage on your home, considering refinancing to reduce the interest burden over the life of the loan. Some lenders may even allow you keep your current term (e.g. 12 years left on a 15-year mortgage).
But don’t forget about closing costs. A good rule of thumb for someone that plans to stay in their home several years is dividing the expected closing costs by the monthly savings – if the answer is 24 months or less, refinancing likely makes sense.
5. Refinance Family Loans
If done properly, lending money to children or other family members can make a lot of sense. The IRS sets rates on these intra-family loans on a monthly basis. On most loans the fixed rate is based on the month the loan begins.
These rates were already low, but rates for March dropped quite a bit from February. April rates are even lower. In April, you could loan money for nine years or less at a rate of .99%. Want to go longer than nine years? You can charge 1.44%. Not bad, right? Mortgage rates are low, but not this low. You can also refinance previous loans to take advantage of current rates.
6. Consider Roth Conversions
Roth conversions can be a great way to take advantage of low tax brackets or ordinary tax losses. Completing a conversion in a down market could magnify the impact. Let’s evaluate a Roth conversion of $100,000 using shares of a hypothetical investment in your pre-tax IRA called Fund ABC. In the first scenario, let’s assume shares of Fund ABC trade at $10 per share at the time of your conversion, meaning you can convert $100,000 to a Roth IRA by transferring 1,000 shares of the Fund ABC to a Roth IRA. If the price of the fund doubles in ten years, the Roth IRA is now worth $200,000.
Now, let’s examine the impact of completing a conversion after the price of Fund ABC dropped to $5 per share. In this scenario, you would convert 2,000 shares to get to your $100,000 target. If the price of the fund still increased to $20 per share in 10 years, now you have $400,000 in your Roth IRA. By converting investments at depressed prices, you have a greater ability to lower your tax bill in the future.
7. Transfer Wealth
Many wealth transfer techniques rely on low asset values and interest rates to transfer wealth. One of our favorites, a Grantor Retained Annuity Trust, is just one strategy that might make sense. If your financial independence is in good shape, and you have a taxable estate, now might be the time to think about transferring wealth to others.
This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.
