It’s human nature to feel compelled to act when going through a stressful period such as a market correction or economic downturn. It comes from a sense of wanting to control the uncontrollable. For investors, this often leads to emotional decisions regarding their investments. Attempting to overhaul your portfolio when markets are volatile can be a mistake. However, there are things you can do to put your financial plan on better footing and satiate the impulse toward action. Here is a list of 4 actions to consider.
Tax Loss Harvesting
This is a time-tested strategy and one that is embedded in our investment process at Kavar Capital. If you have investments held within a non-retirement account, a market correction can present a tax opportunity. Tax loss harvesting allows you to sell a security that has a temporary unrealized loss while simultaneously purchasing a security that is not “substantially identical.” This allows you to “bank” the loss while not disrupting your exposure as you wait for the market to recover. These losses can be used to offset future gains this year or in subsequent years. If you finish the calendar year with more losses than gains, you can use up to $3,000 of losses to offset your ordinary income and carryforward the rest.
If you are considering a Roth conversion because you are in a favorable tax situation or are concerned about higher tax rates in the future, market corrections are a great time to execute this strategy. Think about the mechanics of a Roth conversion: realizing income today for the benefit of tax-free income in the future. This is accomplished by taking a distribution from a Contributory IRA or Rollover IRA and shifting the money to a Roth IRA. Let’s say you were considering converting $50,000 from your IRA to your Roth but due to the market correction those investments are worth 10%-15% less. Would you rather see those investments recover within your pre-tax IRA or your Roth? Most people don’t realize that Roth conversions are typically done with securities as opposed to cash. We would focus on the most distressed part of the portfolio for conversion candidates.
Exercise Stock Options
If you work for a publicly traded company and have Non-qualified stock options (NSOs), it’s a good time to review your option strategy. It can be frustrating to see the value of your options decline along with the market. However, if you plan to hold onto your options you might consider exercising and paying cash for the shares. The reason comes down to minimizing taxes. When you exercise an NSO you will realize income taxed at ordinary income rates. If you hold the shares for longer than 1 year, you will receive the benefit of long-term capital gains treatment. The strategy comes down to realizing less income now because of the depressed price and hopefully paying long-term capital gains on the growth a year from now. There could be an extra benefit this year if Congress decides to reduce or eliminate payroll taxes as those are applied to option income below a certain threshold. Any strategy would be dependent on the expiration and vesting schedule of your options, your financial goals and specific insight into your company’s prospects moving forward.
Review Retirement Cash Flow Projections
There is never a bad time to review your retirement plan to assess your progress and alignment with your financial goals. This is especially true during times of market volatility. The exercise can provide the needed context when evaluating your portfolio and risk tolerance. We often hear from financial professionals that it’s important to “stay the course” and “think long-term.” However, this can be difficult without the anchor of a financial plan. What is considered “long-term”? When will I need to use my portfolio to replace my income? What is my expected withdrawal rate from my portfolio, and can it withstand a market correction? These are all common questions that rise to the surface when you are feeling uneasy about the markets. The context of your financial plan can provide the comfort needed to “stay the course.”
We firmly believe that when your financial objectives are viewed through a holistic lens, short-term market events can create opportunities that will pay dividends in the future. Please reach out to any member of the Kavar Capital team with questions and we’ll continue to keep in close contact.
The views expressed herein are those of Tom Boling on March 11, 2020 and are subject to change at any time based on market or other conditions, as are statements of financial market trends, which are based on current market conditions. This market commentary is a publication of Kavar Capital Partners, LLC (KCP) and is provided as a service to clients and friends of KCP solely for their own use and information. The information provided is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as, investment, legal or tax advice. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s investment portfolio. All investment strategies have the potential for profit or loss and past performance does not ensure future results. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. Charts and graphs presented do not represent the performance of KCP or any of its advisory clients. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results. There can be no assurances that a client’s portfolio will match or outperform any particular benchmark. KCP makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The information is subject to change and, although based on information that KCP considers reliable, it is not guaranteed as to accuracy or completeness. This information may become outdated and KCP is not obligated to update any information or opinions contained herein. Articles herein may not necessarily reflect the investment position or the strategies of KCP. KCP is registered as an investment adviser and only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability.