Find the silver lining in the turmoil on Wall Street
The US stock market is having a bad year.
It could reverse before the year is out, but the S&P 500 index is currently down 20% (January 1 to June 28) and an index of US bonds (the Bloomberg US Aggregate Bond Index) is down about 11% . If you have a diversified, balanced investment portfolio that’s about 50% stocks and 50% bonds, your portfolio is down about 16%. In comparison, cryptocurrencies are down over 50% year-to-date, and shares in Netflix and Peloton are each down over 70%.
The stock market is not for the faint of heart.
Is there a silver lining on the horizon? First, consider your perspective. If you’re an experienced investor, you know that the stock market goes up and down, so occasional downturns don’t come as a surprise. For investors who can weather the downturns, the US stock market has been lucrative. The Wall Street Journal’s Jason Zweig reported that despite the recent downturn, U.S. stocks have returned nearly 13% a year on average over the past decade.
The turmoil we see in US stock and bond markets in 2022 can be attributed to many factors including high inflation (now over 8 percent), the war in Ukraine, supply chain disruptions and the fact that the Federal Reserve has recently hiked interest rates in an attempt to reduce inflation. The Covid-19 pandemic and the stimulus funds that have been distributed since the beginning of 2020 are also contributing to the current instability of the US economy. Between 2009 and 2021, the Federal Reserve kept interest rates very low, fueling economic growth. This likely led to strong stock market performance into 2021, but also to our current high inflation. Some economists believe that the US will enter a recession in the next 18 months.
What can you do? There are several possible strategies. Some of these strategies are complex, so consult your financial or tax advisor before taking any action.
Take advantage of the tax loss harvest
If you have a sizeable taxable investment account with investments that have declined in value, you may want to consider tax loss relief. This only applies to taxable accounts, not retirement accounts. It involves the sale of certain tax lots to trigger (or “reap”) losses, which can then be used to offset capital gains in your investment accounts. Significant losses are likely to be incurred due to the downturn in equity and bond markets in 2022, which could result in significant tax savings. The losses are only offset against capital gains in the current year. For remaining losses, $3,000 can be applied to reduce your income. If you have unneeded losses this year, you can carry them forward to future years and use them as needed.
There are many IRS tax regulations that must be followed, such as: B. the “wash sale” rule, which states that if you buy back the same investment in less than 31 days, you cannot claim the loss. Also, it’s best if you have access to the specific tax packages within each investment so you can manage the short- and long-term losses. These rules are beyond the scope of this article, but there are numerous articles online, notably from TurboTax, Schwab, and CNBC. If you work with a financial advisor or stockbroker, they should offer you tax loss recovery services. If not, give them a call and discuss the strategy.
Perform a Roth conversion
As I have written many times, Roth IRAs are vastly superior to traditional IRAs based on current tax laws. To build a Roth IRA, an investor can fund the account (with income restrictions) or convert a traditional IRA to a Roth IRA.
Some see a downtrend in the stock market as a good time for a Roth rebuild. An example explains this best. Let’s say you have a traditional IRA that was worth $200,000 at the beginning of January. They plan to convert $50,000 (25% of the total) this year and the rest over the next three years. Let’s say the account is down 20 percent since January and is now $160,000. If you go through with your plan and convert $50,000, you will convert 31% to Roth ($50,000 × $160,000) rather than the original 25%. The $50,000 conversion costs you the same amount in taxes, but you defer a higher percentage to the Roth. For an explanation of this strategy, search online for “Kitces.com Roth Conversion on Sale”.
Aim for higher interest rates
The Federal Reserve is raising interest rates. Higher interest rates aren’t good if you’re planning to buy a home and need a new mortgage, or if you have a balance on your credit card from month to month. (If you have a fixed-rate mortgage or car loan, you won’t be affected. The higher interest rates will affect new loans and adjustable-rate loans like credit cards.) However, higher interest rates are a good thing if you’re buying new CDs, Treasury bills, or bonds with the higher interest rates. Banks are starting to increase interest rates on savings accounts, which benefits their customers.
Consider the US Treasury Series I Savings Bonds (I Bonds), which are currently paying a whopping 9.6% interest. The rate adjusts every November and April. Unfortunately, I Bonds can only be purchased through the US Government website at www.treasurydirect.gov and there is a limit of $10,000 per person per year. You can’t cash out the bond for at least 12 months, and if you redeem it five years ago, you’ll lose 3 months of interest. The I Bonds pay interest for 30 years, but interest rates fluctuate every 6 months with inflation. I Bonds are issued by the US government and are considered very safe. More information is available online or on the Treasury Direct website.
The downturn won’t last forever
Realize that the stock market has been lucrative for investors over the long term. Downturns are to be expected, and they don’t last forever. The 34% drop in the S&P 500 in February 2020 (at the start of the pandemic) lasted just 33 days, and it took investors about five months to recoup the loss.
A previous major downturn began in October 2007 and lasted through March 2009. Dubbed the “Great Recession,” the S&P 500 fell 57% and it took investors four years to recoup losses. A 57% loss would indeed be painful. However, as bonds performed well during this period, a balanced portfolio of 50% stocks and 50% bonds was down about 25% instead of 57%. This shows the advantage of a balanced portfolio.
You will see articles advising you to buy the dip, meaning buy more stock while the price is low. This strategy works well, but it is difficult to predict where the bottom will be and if the stock market is ready to recover. If you have a long investment horizon, consider buying stocks after a downturn. Rebalancing your portfolio will also prompt you to buy stocks after a downturn.
Beyond the Dollars
When the stock market falls, one of the best strategies is to hold on and move on to more important issues. This may include spending more time with family and friends, having fun, being in nature as much as possible, reading, exercising, volunteering, or gardening.
Or just realize that today is July 4th and focus on the freedom we have in America. Enjoy some festivities to celebrate and express your gratitude for our many blessings. Dancing in the rain is also encouraged in New Mexico.
Donna Skeels Cygan, CFP, MBA, is the author of The Joy of Financial Security. She was a fee-based financial planner in Albuquerque for more than 20 years before retiring in 2021. She welcomes emails from readers at [email protected]