The roller coaster ride of last week brought back memories of the 2008/2009 recession and market tumble that were much too fresh in investor’s minds. While it is yet to be determined if we are seeing a normal stock market correction or something worse, it might be a good time to think about planning strategies to consider in a downturn. As the old saying goes, if you only have lemons, you need to figure out how to make the best lemonade. Here are some thoughts on strategies that you might want to consider:
- Rebalancing your portfolio – While you don’t want to do this every time the market jumps, if your portfolio is out of line with your target asset allocation, you will experience more or less risk/return than you planned. When working with clients on this, we generally think about making changes if an asset class is more than a few percentage points out of line. A strong equity market like we have seen since March 2009 can leave you with a riskier, more aggressive portfolio than you should have. On the flip side when equities decrease in value you could wind up with a more conservative portfolio than you would like.
- Convert your IRA to a Roth – We have helped a number of clients think through this strategy in the past few years. With the very real possibility that tax rates will rise in the future, doing this analysis between now and the end of 2012 might make sense. If you convert when the value of your IRA is down, there is less tax to pay. Keep in mind that you can always reverse your decision with the recharacterization of the Roth conversion. This can be done up until the filing deadline for your tax return.
- Harvest your losses – An important part of the wealth management process is to regularly harvest any losses in your portfolio so that they can be offset against future gains. Unfortunately, many investors had losses during the 2008/9 downturn that resulted in capital loss carryovers. The upside of this is that these capital loss carryovers can be used to offset future capital gains (without any time limit) and also $3,000 can be offset against ordinary income each year.
- Make gifts to your heirs – With the increase in the estate and gift tax exemption to $5 million, a number of our clients are now making large gifts to their children and grandchildren. Since the gift value is based on the date of the gift, if you are gifting a stock that is down in value, it uses less of your exemption. Making gifts in a downturn can be a great way to pass value on to the next generation, getting the future appreciation out of your estate.
- Continue to dollar cost average into stock funds – If you are an investor who is still adding to their portfolio and doing so on a periodic basis, a correction (as painful as it might seem) is actually “good news” for you as you buy more shares when the prices are lower. This is why it is so important to invest in an ongoing, disciplined way throughout your lifetime.
- Exercise your stock options – If you are a corporate executive who has stock options or other stock based awards you might find yourself accumulating too much stock in your company. A regular, tax wise, program of exercising and selling stock can make a lot of sense as a way to diversify and minimize risk. Since you are taxed on the spread between the value and your exercise price (only for AMT if they are Incentive Stock Options), doing so at a lower price reduces the tax impact of the exercise.
- Refinance your mortgages – As we have said a number of times, one of the “silver linings” to the recent low interest rate environment is that mortgage rates have continued to stay at historic lows. If you have not yet refinanced any debt you have, you should definitely consider this before too long. At some point, rates will rise and you will miss this opportunity.
There are certainly many more strategies that might make sense in an environment like this, but we wanted to mention a few of the ones that we think you might want to consider. Let us know if we can help you think about how these might apply to your own personal financial situation.
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