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It’s a Time to Stay Focused and Think Strategically

By Barbara Trombley, CPA

If you have a retirement account, as many of us do, it is hard not to follow what is going on in the financial markets today. We are officially in a bear market, defined by a drop of 20% or more in a broad market index.

The Dow Jones Industrial Average crossed into bear market territory on June 13 of this year. Unfortunately, bear markets may plummet even deeper than the 20% threshold and may do so over a prolonged period. It is a tough time to be an investor during this scenario but, eventually, the market finds a bottom and investors feel comfortable once again to begin buying, putting an end to the bear market.

Bear markets are usually the result of a recession or some other financial strain. We are not officially in a recession, but many experts think that one is coming. A recession is defined as a significant decline in economic activity that lasts for months or years. This often means that unemployment rises as companies fail or shrink to control costs. Corporate profits fall causing a decline in stock market prices.

Usually, a bear market signifies tougher economic times ahead. Unfortunately, bear markets are ‘normal’ and happen periodically. We actually experienced a short bear market at the beginning of the pandemic. Bear markets tend to be much shorter than bull markets (when stocks rise over a period of time). They also tend to be less statistically severe, with average losses of 33% compared with bull market average gains of 159%, according to data compiled by Invesco.

“It is a tough time to be an investor during this scenario but, eventually, the market finds a bottom and investors feel comfortable once again to begin buying, putting an end to the bear market.”

What should an investor do during a bear market? Risk tolerance, asset allocation and your age really come in to play right now. The percentage of equities in your portfolio should match your risk tolerance and age. For instance, if you are in your thirties and forties and are investing in your 401(k), you could be very aggressive and have a large percentage of equities.

If this is the case, then you should be thrilled to make your monthly deposit into your account. You are buying stocks ‘on sale’ and you have many years to make up any temporary losses in your account. Even if you are a few years from retirement, and depending upon you situation, a bear market could be seen as an opportunity to purchase stocks at a discount.

A prolonged bear market for someone approaching retirement or a new retiree could mean making some changes to your lifestyle. For example, you could limit withdrawals from your investment account and/or eliminate panic selling. When you withdraw money or sell in a bear market it is considered “locking in the losses.” Perhaps you can cut spending or pick up an extra job for the short term, until the economy is on more stable footing.

There are financial products available that could potentially be suitable in many portfolios. In some cases when determined appropriate, an annuity could be used to create more stable income, a REIT (Real Estate Investment Trust) could be used to help diversity a portfolio and many insurance companies offer products with downside protection. Consult your financial advisor for different ideas to help address the volatility in your portfolio.

Perspective is key to a good night’s sleep when dealing with market volatility. Downturns are a normal occurrence in the stock market. Since 1932, bear markets have occurred, on average, every 56 months (about four years and eight months), according to S&P Dow Jones Indices. Make sure to keep emergency funds in the bank to keep market withdrawals to a minimum. Do not make rash changes to your portfolio. There is a saying that ‘time in the market beats timing the market.’ It is very hard to predict the exact best day to sell a stock or to buy a stock. Missing the best days in the stock market, over time, can seriously undermine your performance. Having a plan and sticking to it could yield the best results in the long term.

If you are a new investor, you may want to proceed cautiously. One potential strategy is to dollar cost average any funds that you have into the market (spread the investment over a period of time). This way you are buying at different price points in the market. Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.

No one is predicting when the market bottom will happen, and it is nearly impossible to time. I believe you should see to have a well-diversified portfolio with a mixture of asset classes, though there is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Always remember the adages “This too shall pass” and “Time is on your side.” Those people that have been investing for a while have been through many economic downturns and have survived and, most likely, thrived if they have stayed the course and stuck to their plan!

 

Barbara Tromblay is a financial advisor and CPA with Wilbraham-based Tromblay, CPA: (413) 596-6992. Securities offered through LPL Financial. Member FINRA/SIPC. Advisory services offered through Trombley Associates, a registered investment advisor and separate entity from LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Banking and Financial Services

Tax-loss Harvesting

By Gabe Jacobson

Tax-loss harvesting is the selling of stocks, ETFs, mutual funds, and other securities at a loss with the goal of reducing taxes on other short- and long-term capital gains.

Does It Apply to Me?

Minimizing taxes is an important goal for investors, and tax-loss harvesting is a useful strategy for reducing your total tax bill. If you sell stocks, exchange-traded funds (ETFs), or mutual funds for a gain this year in a taxable, non-retirement, investment account, you may want to utilize tax loss harvesting to reduce potential taxes on any capital gains generated by those sales.

Tax-loss harvesting applies to investments of all sizes, so whether you have $5,000 or $5 million in your portfolio, you can still benefit from tax-loss harvesting.

Full-service financial advisors usually perform tax-loss harvesting as a part of their service and will coordinate with your tax advisor, but robo-advisors are beginning to offer this service for additional fees. These fees may not make sense given your situation, so consult your tax advisor if you are uncertain. Even in a rising stock market, some individual stocks or sectors may decline in price, giving an opportunity for tax-loss harvesting, which can be done at the end of the year but may be more effective during periods of volatility throughout the year.

You may want to consult your tax advisor about tax-loss harvesting if you have a self-service brokerage account. Pay special attention to tax-loss harvesting if you bought and sold securities within the same year because your capital-gains tax will be much higher than if you held the investments for over one year.

How Does It Work?

Tax-loss harvesting is also known as tax-loss selling because it involves selling securities at a loss, generating capital losses. This seems counter-intuitive. After all, most people buy securities hoping that the price per share will increase over time, allowing them to earn capital gains when they sell. These capital gains, like all other sources of income, come with a tax bill attached.

“Tax-loss harvesting works because capital losses are subtracted from capital gains when you file your tax return, so you pay taxes only on the gains in excess of losses.”

Tax-loss harvesting works because capital losses are subtracted from capital gains when you file your tax return, so you pay taxes only on the gains in excess of losses. However, capital gains and losses are grouped into two buckets based on how long the investments were held for.

Capital gains on securities sold more than one year after the purchase date are considered long-term and are taxed at lower rates. In 2020, the long-term capital gains rates range from 0% to 20%, depending on income levels; most people will fall in the 15% range.

However, if securities are sold within a year of the purchase date, the gains are considered short-term and are taxed at the same rate as wages or business income, which in 2020 range from 10% to 37%. These two buckets cannot be mixed, so you cannot reduce your short-term capital gains by long-term capital losses or vice versa.

Sure, it’s nice to mitigate your tax liability, but wouldn’t you lose more money selling your investments for a loss than you save in taxes? Why not just wait for those prices to bounce back and sell for a gain, assuming you expect the investment’s price to eventually recover? The price may recover down the line, but the tax bill associated with any capital gains generated this year cannot be avoided unless a loss is generated in the same year.

The solution is purchasing a similar asset shortly after selling for a loss. This way, you ‘harvest’ the capital loss for tax purposes while making little actual change to your investment portfolio. The IRS instructs that you must wait at least 30 days before purchasing another asset that is “substantially identical” to the asset sold for a loss, but there are enough similar assets available to allow immediate reinvestment in most situations.

An Example to Clarify

Here is a hypothetical example using common investments: the S&P 500 large-company index and Russell 2000 small-company index tracking ETFs (the prices are fictionalized for ease of understanding, but the ETFs are real and can be purchased through most brokerages).

In this example, in your brokerage account, you purchased 10 shares of iShares Core S&P 500 ETF (IVV) on Jan. 1, 2021 for $100 per share, for a $1,000 total investment. On the same date, you also purchased 10 shares of the iShares Russell 2000 ETF (IWM) for $200 per share, or a $2,000 investment. By Nov. 1, 2021 the price of IVV (the large-company index) has doubled to $200 per share, and you decide to sell five of your 10 shares, generating $1,000 in short-term capital gains.

However, you do not want to pay income taxes on an additional $1,000 on top of your regular wages. You notice that the small company index IWM’s price has dropped to $100 per share, so you lost $1,000 on that investment. You do not want to sell at a loss, but then you realize that, if you sell all 10 shares of IWM, you can generate a short-term capital loss of $1,000 which will completely mitigate the short-term gains from your sale of five shares of IVV when you file your income tax return.

You sell all 10 shares of IMW, but you still want to invest in small-company stocks. You immediately purchase $1,000 worth of shares in iShares MSCI small-cap index fund SMLF with the cash received from the sale of IWM. This fund gives you similar exposure to the Russell 2000 small-company index fund (IWM) you just sold without tracking the same index, meaning the IRS will not consider the two funds “substantially identical,” so you can purchase it before the 30 days are up. At this point, you have effectively received $1,000 in capital gains without generating any taxable gains, and you have maintained your portfolio allocations.

Note that, if you had purchased IVV more than a year before you sold it on Nov. 1, 2021, the gain would be classified as long-term, so the short-term loss generated on the sale of IMW would not offset this gain. Speak to your tax advisor regarding capital-loss carry-forwards, as capital losses not used to offset gains in one year can be applied to future tax years.

 

Gabe Jacobson is an associate at the Holyoke-based accounting firm Meyers Brothers Kalicka, P.C.; (413) 536-8510.

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