Although it can be intimidating to watch your portfolios go down, investors should resist the urge to drop everything and quickly go for liquidity. The S&P 500 is down 18% this year and briefly fell into a bear market during Friday’s session – 20% off its highs. The Nasdaq Composite, entrenched in a bear market, is more than 29% away from its all-time high. “Preparing yourself for this portfolio dip is like putting on your armor and preparing for battle so you don’t have to be traumatized,” said Blair Duquesnay, investment advisor at Ritholtz Wealth Management. Follow these steps instead of letting fear drive your decisions. Selling smartly and lowering your tax bill Harvesting tax losses involves selling losing positions in your taxable brokerage account and then using them to offset capital gains made elsewhere in the portfolio. To the extent losses exceed gains, you can offset ordinary income by up to $3,000 per year. Don’t just sit on cash from sales. “Trade the position at a loss and buy something else that will keep you similarly exposed in the market,” said Brenna McLoughlin, senior advisor at Wealthstream Advisors. In this way, you maintain the target asset allocation. Also, be careful when choosing the investments you will use to replace the losers you sold. This is because the IRS prevents you from deducting tax losses if you sell a losing position and within 30 days before or after the sale you buy securities that are substantially identical to what you sold. This is known as the wash-sell rule. How easy it is to find a replacement varies. “If you want to sell a large US fund at a loss, there are millions of funds you can buy to keep investing,” McLoughlin said. She added that it may be more difficult with bond funds because they present themselves against different benchmarks and investors need to assess duration and credit quality when choosing alternatives. Rebalancing Your Portfolio The surge in the market last year has resulted in a huge weighting of stocks in investors’ portfolios. Rebalancing your portfolio allows you to monitor asset allocation. “This situation is strange because stocks are going down and bonds are going down, so this is not a clear opportunity to rebalance,” Duquesnay said. She added that find the biggest winners in your portfolio and get some winnings off the table. The S&P 500 energy segment is up 46% for the year and includes good competitors. Invest the money from those returns and get your portfolio balance back to where it needs to be. This may mean buying shares at high selling prices. “This is how you buy low and sell consistently high without guesswork,” duQuesnay said. Got an IRA? Convert it to a Roth Account Investors can turn a fallen traditional IRA into a tax savings opportunity by converting it into a Roth IRA. A traditional IRA allows you to invest pre-tax or tax-deductible dollars over time, but withdrawals are subject to regular income taxes—plus a 10% penalty tax if you’re under age 59½. If you transfer the account to a Roth IRA, you pay income taxes up front. Funds in this account grow tax-free and can be withdrawn tax-free, subject to certain rules. Roth conversions are especially attractive during periods of market downturn. “If you are considering transferring your IRA to a Roth, now that the value is lower, you will pay taxes on that lower amount,” duQuesnay said. Once the shares are restored, you will have this appreciation in your Roth account on a tax-exempt basis. “Being a long-term investor means being pessimistic in the short term and optimistic in the long term,” she added. Stick to your plan and keep investing.
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