Making lemonade: Top 10 opportunities when markets are down

As we all try adapting to these emotionally and financially challenging times, it helps to remember that there’s a silver lining to every cloud. If the market’s been handing you lemons lately, here are a few ways to try  to turn them into “lemonade” and position yourself for the time when the clouds eventually part.

1. Fund your 401(k)

When markets are down, your investment dollars may go farther. Consider making your retirement contributions now, to take advantage of current prices. While nobody can predict what will happen in the short term, markets have historically rebounded over the long term following declines of 20% or more, as the chart below illustrates:

• Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
• Chart end date is 12/31/2021, the last peak to trough return of 119% represents the return through December 2021. Due to availability of data, monthly returns are used January 1926 through December 1989; daily returns are used January 1990 through present. Periods in which cumulative return from peak is –20% or lower and a recovery of 20% from trough has not yet occurred are considered bear markets. Bull markets are subsequent rises following the bear market trough through the next recovery of at least 20%. The chart shows bear markets and bull markets, the number of months they lasted and the associated cumulative performance for each market period. Results for different time periods could differ from the results shown.
• Source: S&P data © 2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

2. Do a Roth conversion

If your traditional IRA has decreased in value recently, now may be an ideal time to convert those funds to a Roth IRA, potentially saving you money in taxes owed. (The assets you convert will grow tax free). There’s currently no limit on how much money you can convert, although in most situations you’ll have to pay income taxes on what you convert.

Traditional IRAs are usually funded with pre-tax dollars. When you take money out, you pay taxes on those withdrawals at ordinary income rates. In contrast, Roth IRAs are funded with post-tax dollars. Money in Roth IRAs grows tax free and is withdrawn tax free if you’re over age 59 ½ and your Roth IRA has been open for at least five years.¹

We think it’s valuable to have tax-free money available in retirement, especially if you earn taxable income from other retirement accounts and/or Social Security. Roth IRAs also pass to your heirs free of income tax.

3. Fund Roth IRAs for your kids

We think Roth IRAs are also ideal for kids since their long time horizon allows for that investment to grow. Kids will need earned income to contribute to a Roth IRA, and they may only contribute up to the lesser of $6,000 (in 2022) or the amount they earn.² Babysitting, mowing lawns and W-2 income reported on the child’s tax return count as earned income.³

As a parent, you can open a custodial Roth IRA for your underage children.⁴ You may even contribute to the Roth IRA on their behalf, as long as their earned income equals or exceeds what you contribute.⁵

4. Contribute to a 529 plan

A 529 plan is a college savings plan. Funds grow tax deferred and, if used to pay for qualified educational expenses, can be withdrawn tax free. Since the funds inside a 529 are invested in the markets, making your 529 contribution now can benefit from potentially lower prices and higher expected future growth.⁶

As of 2022, each individual may contribute up to $16,000 per 529 beneficiary who qualifies for the annual gift tax exclusion.⁷ The IRS also allows you to “frontload” up to five years of 529 contributions. That means a couple could contribute up to $160,000 in one year, for one child or grandchild, without owing any gift tax.

5. Earn more interest income

With inflation rising, interest rates have increased after years of staying low. An opportunity to capitalize on increasing interest rates is with I Bonds, which are Treasury securities with a variable rate based on inflation. The rate adjusts every six months. For bonds issued between November 1, 2022 and April 30, 2023, the rate is 6.89%.⁸ While there are limits on how much you can purchase ($10,000 per person per year) and how long you need to hold the I Bonds before cashing them in, they can be a good solution for investors who don’t need immediate access to that cash and who are concerned about inflation.⁹ Your financial advisor can help to determine whether I Bonds are right for you.

6. Rebalance your portfolio

Amid market volatility, we think it’s important to stick to your target allocation of stocks versus bonds. When stocks decline faster than bonds, you may end up holding more in bonds, on a percentage basis, than you intend. We suggest that you consider trimming back on bonds and buying stocks to maintain your long-term asset allocation target. In short, you may be able to “buy low and sell high.”

7. Harvest your tax losses – and diversify

Any time markets move, the value of a security (stock or bond) you hold may drop below the price you paid, which results in an “unrealized loss.” If you sell that position, your unrealized loss becomes a realized “harvested” loss.

But be careful. If you buy the same or a “substantially identical” security within 30 days before or after selling at a loss, it's called a "wash sale" and the IRS won’t allow you to deduct this loss. For example, if you sell certain shares at a loss on November 7 and repurchase them on November 16, this wash sale will negate any tax benefit. That’s true even if you buy and sell the security in different investment accounts.¹⁰ Discuss tax-loss harvesting with your financial advisor, who is familiar with the strategy and can help you take advantage of this tax-saving opportunity.

8. Make estate gifts now

When market values are lower, it can be advantageous to give assets to others. If you’re likely to exceed the estate tax exemption ($12.06 million per person in 2022), consider gifting some of those assets to your non-charitable heirs now.¹¹ You’ll use less of your estate tax exemption than if you gifted them after the assets had recovered in value. Instead, your heirs may benefit from future appreciation of the assets.

9. Wait to take Social Security

When you reach your “full retirement age” as defined by the Social Security Administration, you have the option to take your benefits or wait until age 70. For every year you wait until age 70, you’ll get an 8% increase in your eventual benefits.¹²

Every situation is unique, and in some cases it still makes sense to claim your Social Security early. Talk to your financial advisor about what’s appropriate for you.

10. Review your financial plan

As market conditions change, it’s a good time to “stress test” your financial plan. If you retire when markets are extremely low, do you know how your plan will hold up? What else do you need to plan for under such unfavorable conditions? Consider taking a fresh look at your financial plan to ensure the road ahead still points in the right direction.

Market volatility can feel unsettling, but by controlling what you can control, you can make sound financial decisions – even in challenging times.

Don’t hesitate to contact us if you’d like to discuss any of these strategies in greater detail.

¹ https://www.kiplinger.com/retirement/retirement-plans/roth-iras
² https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits#:~:text=For%202022%2C%202021%2C%202020%20and,taxable%20compensation%20for%20the%20year
³ https://www.forbes.com/sites/chriscarosa/2021/07/25/yes-babysitting-and-lawn-mowing-money-can-go-into-a-child-ira/?sh=636d47733482
⁴ https://www.bankrate.com/retirement/custodial-roth-ira-starting-ira-for-your-child/
⁵ https://www.businessinsider.com/personal-finance/roth-ira-for-kids#:~:text=Anyone%20can%20contribute%20to%20the,can%20withdraw%20funds%20from%20it
⁶ https://www.investopedia.com/articles/managing-wealth/072516/why-you-should-front-load-your-529-plan.asp
⁷ https://www.savingforcollege.com/article/maximum-529-plan-contribution-limits-by-state#:~:text=529%20plans%20do%20not%20have,the%20annual%20gift%20tax%20exclusion
⁸ https://treasurydirect.gov/savings-bonds/i-bonds/i-bonds-interest-rates/
⁹ https://www.treasurydirect.gov/savings-bonds/i-bonds/
¹⁰ https://www.forbes.com/advisor/investing/wash-sale-rule/
¹¹ https://www.irs.gov/businesses/small-businesses-self-employed/whats-new-estate-and-gift-tax
¹² https://www.kiplinger.com/retirement/social-security/601475/3-reasons-to-wait-until-70-to-claim-social-security-benefits#:~:text=You'll%20Get%20a%20Bigger%20Social%20Security%20Check%20%E2%80%93%20Guaranteed&text=That%20reduction%20is%20permanent.,off%2C%20up%20until%20age%2070

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