Tax-smart investing strategies for a down market

By Brian Carter, CPA

Let’s be honest: The market’s performance in 2022 has been disappointing, at best, and for many investors ‘alarming’ would be a more accurate description. Equity prices are declining and volatility is high, with each new day bringing the potential for more carnage as jobs reports, inflation numbers and other economic data roll in. But, while bear markets are inevitable, they are not all bad news. In fact, down markets present advantages and offer opportunities for tax-savvy investors. These strategies can help you make use of this rough patch on Wall Street.

Roth Conversion

For investors who hold significant balances in a traditional IRA, today’s tough market conditions represent a stellar moment to convert some, or all, those funds into Roth savings. Moving the money from pre-tax to Roth dollars requires you to treat the amount converted as taxable income in the year of the conversion. By making the switch while the balance is at a relative low point, you’ll minimize the tax hit of the conversion. And, when markets rise again and take your Roth account balance with them, withdrawals will be tax-free.

Tax Swapping

You probably have a handful of particularly poor performers in your portfolio that you’d love to dump. Rather than ditching the whole portfolio, or sector, consider selling just those positions you don’t see a future for and reinvesting the proceeds into individual stocks, or funds, that you expect to perform better in the future. Making the switch now allows you to pick up attractive investments you’ve had your eye on while they’re on sale.

Tax Loss Harvesting

If your tax swapping activities resulted in a capital loss, consider it part of a timely tax loss harvesting strategy. Selling off poorly performing investments, that you really don’t want to hold anymore, locks in the loss. It is true, but it also lets you offset capital gains from this year while reshaping your portfolio to match your preferences today. You can deduct capital losses against capital gains and deduct an additional $3,000 in capital losses against ordinary income and carry forward any remaining loss to the following year to offset future capital gains.

Portfolio Rebalancing

Periodic portfolio rebalancing is basic financial housekeeping for all investors. The long bull market likely left your portfolio allocation misaligned with your goals for each account, at least to some degree. While markets are down, you can rebalance without incurring the painful tax consequences that could accompany a sale of high-performing stock at its peak. Sell what you need to now, in order to keep the portfolio balanced properly; the drop in stock prices means you won’t generate as much taxable income today as you would have a year ago. Plus, you’ll be paying less when you buy what you need to establish the optimal balance.

Leveraging Retirement Accounts

You contribute to a 401(k) and IRA every year, of course, but are you maxing out those contributions? How about a health savings account (HSA) and 529 plan to fund education costs for your kids and grandkids? Stashing money up to the legal limit, in each tax-advantaged account you’re eligible to hold, is highly advisable during a down market. By investing now you’ll be getting more bang for your buck. When the market goes back up, which it always does, you’ll be glad you invested those dollars while prices were low.

Bargain Hunting

Tax-advantaged accounts aren’t the only investing opportunity that’s attractive while the bears are in control. If you’ve got a taxable investment account, this could be a great time to make carefully selected investments — it’s a sale!

Buying in the midst of volatility can feel risky because it is. When you buy in the kind of market we’re witnessing this year, the value of your investments may well go down in the short term and that’s never a pleasant experience. But dollar cost averaging requires you to put in money when times are tough, as well as when the market is booming, and that’s an approach that is both time-tested and effective.

Investing now may feel more anxiety-provoking, but your sallies into the market now are more likely to generate capital growth than investments made near the market’s peak. Do your research, diversify as you expand your holdings and take the plunge while the sale prices last.

If you’ve taken advantage of the strategic opportunities that the bear market offers and you’re losing patience with the ongoing volatility, just stick to the first law of investing in any type of market: Don’t risk anything you can’t afford to lose. You can take comfort in the certain knowledge that, eventually, the economic horizon will brighten and the market will start heading upwards once again. Down markets never last forever — they only feel that way.

Brian Carter

Brian Carter, CPA, is a partner with Mauldin & Jenkins, LLC. Brian received his BBA in Accounting from Mercer University in 1996 and is licensed as a CPA in Georgia and Florida. Since joining Mauldin & Jenkins, Brian has specialized in providing a variety of accounting, auditing and tax services to not-for-profit organizations, affordable housing developers, restaurants, construction contractors and manufacturing and distribution entities. Brian also consults with not-for-profit board of directors on governance and policy issues and is a frequent speaker to various trade and civic organizations on topics affecting the not-for-profit industry. Brian is a member of the American Institute of Certified Public Accountants, the Florida Society of Certified Public Accountants and a member of the Leadership Florida Cornerstone Class 38.

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