The Upside of a Down Market

Dear Carrie,

This recent market is depressing. It’s torture to see the value of my portfolio go down so fast. I’m still making monthly contributions to my 401(k) but don’t know if that’s wise. Any advice you can offer?

—A Reader

Dear Reader,

It’s definitely not fun to see losses in your portfolio and possibly even more difficult to continue to make contributions with the markets so volatile. This is part of what makes investing so hard. It can take a long time for investing to pay off and along the way there will most certainly be challenges.

Historically, though, every market downturn has been followed by new highs. It may take months, or even years, but if we look at history, eventually the markets recover. And in the meantime, you may be surprised to learn that there can actually be some opportunities in the midst of all the gloom and doom. Let’s take a look at a few strategies that many investors overlook.

Buying on sale

Hearing that you’re still adding money to your investments is music to my ears. It’s not easy to buy when markets have dropped, but this may actually be the best time.

Why? When markets are down and you invest new money, you're buying at lower prices. While there’s no guarantee if or how long it may take your investments to rise, it’s still a good bet based on market history. Despite all the volatility over the short term, over the long term, it pays to be an investor.

Dollar-cost averaging

When market volatility is so high, it’s easy for your emotions (mostly fear) to get the best of you. I worry that new investors will stay on the sidelines, thereby missing out on future market gains. And even seasoned investors can panic, wreaking havoc on their investment plan.

That’s where the value of dollar-cost averaging comes in. Dollar-cost averaging is just financial-speak for investing the same amount of money regularly (say, every month), regardless of what the markets are doing. When prices are high, you buy fewer shares. And when prices are depressed, as many are today, you buy more shares with the same amount of money.

By investing regular amounts, like you're doing in your 401(k), as prices go up and down, you buy more shares when things are cheaper and fewer shares when things are more expensive. By wading in gradually, as opposed to investing all your money all at once, dollar-cost averaging can help you limit your losses in the event the market declines.

Roth conversions

When you convert money from a traditional IRA or 401(k) to a Roth, you're subject to paying income taxes on all of the untaxed contributions and earnings. That can add up to a pretty big tax bill depending on the amount you're converting.

Higher reported income as a result of a Roth conversion can result in higher Medicare premiums and how much you pay in taxes on Social Security. That can be an unwelcome surprise. But by doing a Roth conversion when your portfolio is down, you can potentially save some cash in taxes.

For example, if you were converting 100 shares of stock now worth $50/share as opposed to $100/share, your Roth conversion is now 50 percent cheaper. In other words, you're converting the same number of shares, but at lower prices, which can lower your tax bill. A bear market can be a great time to consider a Roth conversion. But before you convert, consider several factors including:

• Is your tax rate this year likely to be lower than when you will need the converted assets?
• Do you need the money within five years?
• Can you pay the taxes with other taxable account assets?

Make sure you understand how a Roth conversion will impact your overall financial plan and consult with your tax or financial advisor.

Tax-loss harvesting

If you have losses in taxable accounts like a brokerage account, you can take advantage of a technique called tax-loss harvesting. (It won’t work in retirement accounts like an IRA or 401(k) because losses in a tax-deferred account can’t be deducted.)

By selling assets—like stocks, bonds, mutual funds, ETFs—at a loss, you can offset the taxable liability from selling an investment that has a capital gain. You can deduct up to $3,000 in ordinary income taxes each year above this amount and carry over any remainder into future years.

Respite from Required Minimum Distributions

Under the CARES Act, 2019 required minimum distributions (RMDs) due in 2020 are postponed for retirement accounts such as IRAs, 401(k)s, Roth 401(k)s and also for inherited accounts. This new law lets retirees keep that money in their accounts, potentially recouping some of the market losses until the economy turns around.

If you’ve already taken an RMD in 2020, check with your tax advisor about your ability to convert the RMD to a Roth.

Look at a market decline as an opportunity

As improbable as it may seem, there can be a bright side to a down market for disciplined investors. The biggest risk of a steep market decline and volatility is that you'll panic and abandon your plan. Instead, consider taking advantage of the opportunities and strategies above.

If you have questions about your long-term plan, talk with a trusted tax or investment advisor for help. They can help you see the big picture, focusing on your long-term objectives, and perhaps capitalizing on market dips along the way.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.