The year so far has presented a challenging time for investors. However, periods of market dislocation also can provide opportunities on the financial planning side to create a better long-term position.
Here are five things you can do right now, to prepare for the future financially and take advantage of lower equity prices.
Create a Personal Balance Sheet and Income Statement
Many of us are still spending most of our time sheltered in place and have already watched everything new Netflix has to offer. Now may be a time to take advantage of the lack of travel or social engagements to get your financial house in order.
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Start by completing a financial plan with a personal balance sheet and income statement. Just like with a business balance sheet, a personal balance sheet breaks down assets, income and liabilities, such as debt and financial commitments. A budget then helps forecast where spending is expected, savings can be gained and goals met. According to a 2018 study by the Certified Financial Plan Board of Standards, “Consumers who have a budget feel more in control (62%), more confident (55%) and more secure (52%).”
Review Your Asset Allocations and Rebalance Your Portfolio
The coronavirus and its economic fallout have caused some assets to move by 15%-25% in a couple of days in both directions. A study from the CFA Institute states that rebalancing a portfolio of 60% stocks, 30% Treasuries and 10% commodities quarterly led to a 21% improvement in the risk/reward ratio, with both higher returns and lower volatility. Market dislocations allow for rebalancing of portfolios to match risk tolerance in a more tax-efficient manner.
The market volatility can also reveal your risk tolerance. For instance, do you experience a tremendous amount of stress when a stock tumbles or do you know that this is part of the ups and downs of daily trading? Based on your response to the recent market volatility, you can now adjust your portfolio accordingly. The current environment can give the ability to sell appreciated assets and get risk tolerance in line with long-term goals.
Harvest Losses in Taxable Accounts
Compared to 2019, equity investors now have a higher likelihood of having losses in certain securities than can be used to offset capital gains on a tax bill. By “realizing” a loss on a security that dramatically dropped in value and buying a similar equivalent security, you still maintain an overall investment allocation but can greatly benefit the timing of your tax payments and reduce your tax bill due next April.
Covert Traditional IRAs to Roths to Tap into Tax-free Growth
The decline in your portfolio equates to a similar level of income tax savings when converting a traditional IRA to a Roth IRA at depressed levels. You must pay taxes on the amount you convert, but since stock values are down, the tax bill on the transaction would be lower as well. Then, when the market bounces back, the gains appear in the Roth IRA and will be permanently tax-free.
This could be a particularly good strategy for clients with longer time horizons or those who expect their 2020 income to be lower than future years. Please ensure to consult a tax professional to ensure there are no other effects on your tax situation.
Gift or Transfer Depressed Assets Outside the Estate
The short-term mispricing of assets can provide significant tax benefits to gift/sell them out of an estate at a big discount. This means that assets can be transferred to a family member with lower taxes due to its “bargain” prices that are expected to appreciate during a market recovery. Funding 529 college savings plans now and allocating into stocks at potentially short-term depressed levels is also a good idea. This is essentially investing in savings plans and stocks that are at lower-than-expected prices but may see increased value after the economic recovery.
While no one likes seeing the value of their investment accounts drop, there are some benefits to lower balances from a tax, estate and investment strategy point of view. Sometimes, you must fight the urge to freeze and act when times are bad to take advantage of the best opportunities.
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