An investment market decline can create financial opportunities for alert investors, whether the decline is short and sharp or long and drawn out.
Market declines can present opportunities for those who put emotions aside, ignore the headlines, and consider which long-term actions could be best for them.
One strategy to consider is to convert a traditional IRA to a Roth IRA.
The converted amount is included in gross income as though it were distributed to you. You pay income taxes today instead of years from now.
In return, after the conversion the income and gains compound tax-free within the Roth IRA. Principal is tax-free when distributed to you and distributions of income are tax-free after a five-year waiting period. Principal and income also are tax-free when distributed to heirs who inherit the Roth IRA.
You don’t have to sell assets to do a conversion. In most cases, you can direct the traditional IRA custodian to transfer shares of stocks or funds to a Roth IRA. The value of the assets on the day of the transfer will be the amount included in your gross income.
The benefit of a market decline is that you can convert more shares of an investment for the same tax cost as before the decline. Or you can convert the same number of shares for a lower tax cost.
Suppose you had 100 shares of an ETF that sold for $10 per share a couple of months ago. If you had converted them, you would have included $1,000 in gross income. Today, you can convert them and include perhaps only $800 in gross income.
That’s an opportunity to make a conversion at a 20% discount. Plus, when the shares recover all the appreciation from the recovery to their previous high value will be tax-free, as will any additional future appreciation.
In taxable accounts, a market decline is a good time to consider tax loss harvesting.
Look for investments that now have paper losses. If you sell them, the losses can be deducted against any capital gains you’ll have this year. Up to $3,000 of losses that exceed the year’s capital gains can be deducted against other income.
Any capital losses you don’t deduct this year can be carried forward to future years to be deducted in the same way.
Another strategy to consider after any significant move in asset prices, either up or down, is rebalancing your portfolio.
At one point an asset allocation was established for your portfolio. The allocation had an appropriate risk level for you.
Changes in asset prices change the asset allocation as well as your risk level and potential future returns.
When stock prices rise, a greater percentage of your portfolio than intended is allocated to stocks. After stocks decline, you have a lower allocation to stocks.
After a market decline, consider whether stocks now are too small a portion of your portfolio. You might want to sell other assets or use cash to increase the stock allocation.
In these days of no-commission trading, rebalancing assets in a tax-deferred account doesn’t cost anything.
In a taxable account, you might owe taxes if you sell appreciated assets (such as gold) to buy more stocks. Determine if the tax cost is worth restoring the original allocation of the portfolio.
Most investors, instead of watching headlines or listening to talking heads on television, should consider these moves.
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