3 Strategies to Employ in Market Downturns

March 13, 2020

No one likes to see their investment balances fall, and I am certainly no exception. A famous investment saying is that “stocks take the escalator up, and the elevator down” and our recent experience has seen that adage come to life. But the important question is what should we do about it?

The overwhelming advice I’ve seen from many advisors is to hold steady and do nothing. This is likely better advice than panic-selling, however, I think there is a much better alternative – taking advantage of the situation. When life gives you lemons, make lemonade.

I always recommend to “focus on what you can control” and there are many things you can still control during investment pullbacks. Here are three active, “lemonade” strategies you should consider capitalizing on.

1) Trading in Taxable Accounts

Taxes on capital gains can discourage more frequent trading in taxable investment accounts, like your brokerage. This is often a good thing as it keeps us invested for the long-term. However, there may be good reasons to trade out of a position that has unrealized capital gains.

Let’s say you hold some individual stocks, but you want to diversify your portfolio. Use this market downturn as an opportunity to sell those positions, at a much lower gain than a few months ago, and reinvest in a more diversified position. Selling after a market drop feels wrong, but if you limit your tax bill and increase your diversification, it’s a great outcome for the future.

Similarly, now is a great time to alter your taxable portfolio if you’ve been wanting to make a change. For instance, if you’ve been considering adding more sustainable investments to your portfolio. Use the current market weakness as an opportunity to switch your taxable portfolio to an environmentally-friendly one, while paying less capital gains than you would’ve had you switched two months earlier (or even no capital gains, if those positions are now at a loss).

This is also an opportunity to engage in tax-loss harvesting from taxable accounts, if you are comfortable with your current investment lineup. You can reduce your future tax bills by opportunistically selling positions at a loss which can then be used to offset current or future capital gains, and even reduce up to $3,000 in earned income. It’s important to strategically reinvest those proceeds in a similar, but not identical, investment such that you don’t miss out on the eventual recovery.

2) Convert to Tax-Free Growth

Tax-deferred investment accounts are great savings vehicles but eventually you will have to pay taxes on distributions from those accounts. You can convert your investments from tax-deferred accounts, like traditional IRAs, to tax-free accounts, like Roth IRAs, but you must pay taxes on the conversion amount at your income tax rate for that year. I often recommend that clients consider such a conversion if their income is lower than usual in a given year, since their tax rate would be lower on the conversion. The first few years into retirement are a good example.

Following market weakness is also a great time to consider a Roth conversion as well. Since taxes are due on the amount that’s converted, you would pay less in taxes now than if you converted a few months prior. And, when the market eventually recovers that growth will be tax-free since the bounce back happened in your Roth account.

There are other considerations to factor in, such as your current tax rate and expected future tax rate, but now could be an ideal time to seek out tax-free growth. It’s best suited to speak with a financial advisor, like myself, when considering these options. I use helpful tools from financial planning software that allows you to visualize when Roth conversion may be right for you.

3) Rebalance Patiently but Aggressively

Future investment returns are based on many factors, but the price you pay is an important one. When prices fall, all else being equal, future returns go up. “All else being equal” is a big assumption and there is oftentimes much more at play, but risky assets tend to get sold at discounted prices during times of panic.

Now is a good time, therefore, to buy some of those risky assets at a discount, particularly if you have some defensive investments that have held up relatively well. Patiently rebalancing your portfolio into more growth assets could boost your future wealth, if you are comfortable with such a move.

It’s important to consider your time horizon, use of investment funds, and comfort level with risk before employing such a strategy. But, having a strategy in mind and following it with discipline can be helpful during these times. I can help you think through these decisions and outline a patient strategy to try and take advantage of the current market weakness. No investor can time markets perfectly, but as Warren Buffett said, “It’s wise to be fearful when others are greedy and greedy when others are fearful”.

The views in this materials were those of the Advisor at the time of writing this report and may not reflect the views Wealthcare Advisory Partners LLC. These views are intended to assist clients and do not constitute investment advice.

Advisory services offered through Wealthcare Advisory Partners LLC dba Pine Harbor Wealth Management LLC. Wealthcare Advisory Partners LLC is a registered investment advisor with the U.S Securities and Exchange Commission.