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March 23, 2023
Volatile markets can shake the confidence of even the most committed long-term investors. Starting with a comprehensive financial plan, understanding just how much risk you need to take with your portfolio to accomplish your long-term goals and objectives is the first step. While we certainly can’t prevent or even anticipate when down markets might happen, here’s 5 moves you can make with your portfolio during a downturn.
Loss Harvesting is a technique that sits at the intersection of tax and investment planning and is applicable only to non-retirement investments like those in an after-tax brokerage account. It’s the process of selling an existing holding to lock in “paper” losses, and immediately purchasing a similar investment to maintain the same exposure inside your portfolio. These booked losses can then be used to save on taxes by offsetting future capital gains or a portion of your ordinary income.
Loss Harvesting seeks to minimize taxation over time, can help add efficiency to a portfolio, and could be especially beneficial for the higher-income investor. We often hear that we shouldn’t make changes to our portfolio in a down market, but we may find that is only partially true given the power that loss harvesting can have.
It’s important to note that tax loss harvesting may trigger the wash sale rule1 if a similar security is immediately purchased so proposed transactions should be carefully reviewed by an advisor before being completed.
During times of significant volatility (such as the COVID Crash), we often see differences in performance from one asset class to another. It is for this reason diversification is deemed as being important to the long-term investor.Opportunistic rebalancing seeks to take advantage of high volatility in markets and involves the process of selling from assets that have outperformed relative to other holdings and buying into the underperforming asset classes. One of the more common examples of opportunistic rebalancing might include selling a portion from an investor’s bonds during a stock market selloff, as bonds tend to fare better in these environments, and using those dollars to make strategic purchases in stock market holdings at lower prices. Through this process, we seek to achieve the natural “buy low, sell high” that our grandfather always told us about!
Downturns may present significant opportunities for the long-term investor to make strategic investments in the stock market. This can be especially beneficial for those who have sizable balances of cash and may be looking for opportunities to invest. One approach for this type of investor is to follow a “dollar-cost averaging strategy” where an investor will make disciplined investments periodically until a sum of cash is fully invested in the market. This might include investing $100k of cash in $25k increments over a 4-month period.
Another simple strategy might include increasing your savings rate inside your 401(k) or other savings vehicles to make additional investments at reduced prices.
The most important consideration here is to be disciplined in your approach and stick to a plan, removing as much emotion from the decision as possible.
The most aggressive, growth-oriented investors with a long-term time horizon might find periods of market downturn exciting chances to be opportunistic with their investment portfolio. This might include increasing overall portfolio risk level – rotating more dollars into the stock market and away from bonds/fixed income or strategically buying into those asset classes most negatively impacted in times of volatility.Any decision to change an investor’s overall portfolio risk level should be made very carefully, with a deep understanding of how those changes might impact the long-term outcomes of your personal financial plan.
As investors, sometimes our best action is taking no action at all. Acting during times of high emotion, which often accompanies market volatility, typically results in poor decisions being made.
Without significant discipline or the help of a professional, it can be easy for emotional investors to make decisions that will have lasting negative impacts on their portfolios and long-term financial and retirement planning.
As always, the best tool to weather times of fear and uncertainty is a plan that provides an in-depth understanding of your personal financial future. Having a financial advisor to help guide the decisions you make today as an investor can ease the discomfort of market downturns. If you’d like to meet with Cerity Partners advisor, I encourage you to reach out and start the conversation about your personal circumstances.
1 The wash-sale rule is an Internal Revenue Service (IRS) regulation that prevents a taxpayer from taking a tax deduction for a loss on a security sold in a wash sale. The rule defines a wash sale as one that occurs when an individual sells or trades a security at a loss and, within 30 days before or after this sale, buys the same or a substantially identical stock or security, or acquires a contract or option to do so. A wash sale also results if an individual sells a security, and the individual’s spouse or a company controlled by the individual buys a substantially equivalent security during the 61-day wait period. The point of the rule is to prevent investors from creating an investment loss for the benefit of a tax deduction while essentially maintaining their position in the security.
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Stephen is a Principal in the Indianapolis office. He partners with individuals to advise and assist on the topics of investment management and financial, tax...
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