Insight

This morning, I spent some time reflecting on the recent spike in volatility in the investment markets and wanted to share some insights that I hope will be helpful for anyone getting nervous about their portfolios. The first thing to note is that this is completely normal market behavior. In fact, a lot of professionals would say that this pullback is actually a sign of a healthy market!

The stock market rebounded nicely following the rapid drop last week. This is a good sign and what the market should have done, as the US economy is still relatively strong and unemployment is relatively low. This would lead us to believe that the economy should continue to grow going forward. That said, economic data has been weakening recently. Still growing, but at a slower pace. Couple that with high valuations, and we should expect to see more volatility, like we did these past two weeks, as the markets grind their way higher. If our expectation is for more volatility and pullbacks going forward, what should we do now to prepare?

First thing, first: Don’t panic! As I mentioned above, market pullbacks are a normal feature of healthy markets. I have seen way more money lost by investors trying to avoid market corrections than money actually lost during pullbacks. Fear-based selling during a market downturn is the easiest way to turn temporary, paper losses into permanent losses. So, if you shouldn’t be selling, what can you do to take you mind off the value on your account statement during turbulent times?

If I have learned anything from my wife’s line of work as a veterinary behaviorist, it is that the easiest way to alter a stressed animal’s behavior is not to correct the unwanted behavior, but rather to teach the animal the desired behavior and reward them for it. This positive reinforcement strategy is referred to as redirection and can be a valuable strategy for investors during turbulent times.

The first thing you can do is create a financial plan. Working with a financial planner, you can take your mind off the short-term distractions of the market and focus on bigger picture decisions you can make as an investor. These will be way more impactful to your financial situation over the long run than any short-term trading strategy. Additionally, by creating a financial plan, you will have a road map to help guide you through difficult stretches of market volatility, like those we are expecting currently. Some other strategies your financial plan may uncover are as follows…

Accelerated Roth Conversions. Roth IRAs are probably one of the most misunderstood investment vehicles. The main difference between a Roth IRA and traditional IRA is that Roth IRAs are always invested with after-tax money, so deposits and earnings withdrawn from it are not taxed if they meet the 5-year holding requirement, as opposed to traditional IRAs, where pre-tax deposits and earnings are withdrawn at earned income tax rates. Converting money into a Roth account allows you to move the growth of your assets into a tax-free environment, with the caveat that you will have to pay income tax today on any amount of pre-tax money converted to Roth. This makes a market pullback the ideal time to do a Roth Conversion, because you are paying taxes on a smaller amount and shifting the recovery into a tax-free environment. This is a complicated strategy and should not be done without the guidance of a financial or tax professional!

Buying the Dip. It is estimated that Americans have over $6 trillion dollars sitting on the sidelines in money market funds. If you are in this position and your financial plan dictates that this money would be better served in a faster growing environment, a market correction can be the perfect time to take advantage of low prices to put your money to work. Again, it is important to have a financial plan to know which assets should be kept in a safe environment and what can be used to buy the dip. I would, again, advise working with a financial professional to develop a financial plan prior to moving funds.

Tax Loss Harvesting. This is an important distinction from selling out of the market. Tax loss harvesting involves selling positions that are at a loss to book the loss for capital gains tax purposes. Extra care needs to be taken when enacting this strategy, because if the IRS determines that you have sold an investment at a loss and purchased a “substantially identical” investment within 30 days of the trade, you have made a wash sale and will not be able to deduct the loss from your capital gains for the year. For this reason, it is highly recommended to work with a financial or tax professional when harvesting tax losses and reallocating those assets.

Review your Estate Plan. Maybe you want to take your mind off investments entirely. Reviewing your estate plan is a great activity to keep busy when the markets are experiencing volatility. Especially with the TCJA currently due to sunset at the end of 2025, many Americans are wondering what, if anything, they should be doing now to prepare for the estate tax exclusion to get cut in half. Working with a financial planner in conjunction with an estate attorney is a great way to identify strategies to minimize the tax burden your estate will incur when you pass and maximize the assets you pass to your loved ones. Furthermore, like Roth conversions, market pullbacks are a great time to maximize the value of your tax-free gift to family members under a lifetime gifting strategy. Again, it is highly recommended to work with a financial or estate professional when implementing these strategies.

In conclusion, we can see that there are many positive activities we can take advantage of when the markets are experience turbulence. By creating a financial plan, we give ourselves the road map to success to guide our decisions mindfully during difficult times. If you or someone you know could benefit from working with a financial planner, please don’t hesitate to reach out. My line is always open for conversation!

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