Wealth Planning Insights
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Sometimes It’s OK to Feed the Bear
Keith Fenstad, CFP®, July 2022
Market volatility is inevitable and a part of the investment experience. Since 1926 the S&P 500 has experienced 26 bear markets – defined as a decline of 20% or more from its previous high. These periods are unnerving and uncomfortable, but they should not be unexpected. Volatility (aka “taking risk”) is the price an investor pays for a superior return on their investment. For a well balanced diversified portfolio, committing to the investment process should ultimately lead to a full recovery and on to new highs.
With this as a backdrop, corrections and bear markets can be viewed as opportunities to enhance a client’s wealth planning objectives. This is not market timing in the traditional sense but simply reframing a temporary market downturn into a positive long-term planning opportunity. Let’s look at some of these opportunities.
Add sideline cash
When markets are down substantially from their all-time highs, it is a great time to add accumulated cash to a long-term investment portfolio. The deeper the decline, the more the reward on those contributed funds.
| % Decline | Reovery Return |
|---|---|
| 20% | 25% |
| 30% | 43% |
| 40% | 67% |
| 50% | 100% |
For every dollar invested when a portfolio is down 40%, that dollar achieves a 67% return when fully recovered. See below for the "recovery return" after various levels of decline.
This is not magic market timing or crystal balls, it’s just math!
Make an IP change
In the same vein as adding cash to the portfolio, adding stock exposure through a more aggressive investment policy accomplishes a similar result. Tanglewood’s investment policies range from 30% equity to 100% equity. Turning up the equity dial a notch after a significant decline will take advantage of a downturn with more equity growth during the recovery.
It's very important to keep in mind that with either of these moves you never know where the bottom will be. You might initially feel good investing or getting more aggressive when down 20% or 30% but only to see it continue to fall further from there. Being too early can cause pain and/or regret in the short-term, but doesn’t change the math or advantage ultimately achieved when fully recovered.
Roth conversions
For someone considering a Roth conversion, a market decline may be the perfect time to pull the trigger. The greater the decline, the more a conversion is “on sale”. Remember the conversion is taxable income in the year it is converted. Most often, the goal is to target a specific conversion amount to fit within the client’s tax budget. When market prices are low, more shares get converted to reach the desired conversion amount.
The real payoff comes when the market (eventually) turns around and the conversion recovers tax free inside the Roth instead of the taxable IRA.
Accelerate gifts
Gifting is a simple and smart way to transfer wealth and reduce estate taxes over time. Whether using the annual gift exclusion ($16,000) or making a significant gift that uses some of the $12,060,000 per person lifetime exemption, a bear market provides additional leverage since the gift values are temporarily depressed.
Business owners may also find this to be a good opportunity to gift depressed company stock if their business has also been negatively impacted. Splitting the stock into voting and non-voting shares will further reduce valuations and provide an opportunity to give away value without losing control.
Diversify
A sharp decline in market value should reduce the tax impact of selling an investment with a large unrealized capital gain. We recommend not letting the “tax tail wag the dog” but if realizing that large gain was a barrier to diversifying, a bear market may open up that opportunity and lessen the tax pain.
Tax loss harvesting
This strategy is nothing new and one that Tanglewood implements when the right opportunities present themselves. Selling positions at a loss and simultaneously buying a similar security, pockets the loss to use against gains later while remaining invested. They never go to waste as any carryover losses from one tax year roll over indefinitely until fully utilized.
Accelerate IRA RMDs
Similar to a Roth conversion, taking an IRA RMD when the market is down can be a tax wise move. The reinvestment of the RMD in an after-tax account essentially “steals” appreciation from the IRA and shifts that growth from an ordinary income tax environment to a capital gain environment.
Tanglewood’s Wealth Advisors stand ready to discuss and analyze whether any of these moves make sense in your particular situation.