Throughout the first three quarters of 2022, the United States economy has seen significant short-term volatility, with the S&P 500 seeing a 23% pullback in the summer months. While still maintaining sound investment principles of asset allocation, diversification, and having a long-term time horizon for money invested, many investors are seeking ways to take advantage of this volatile time. Here are a few discussions we’ve been having with clients in 2022 to take advantage of a market downturn:

Roth Conversions

For clients that were planning on converting money from their Traditional IRA to their Roth IRA, a down market is a generally advantageous time to accelerate this planning opportunity. For example, let’s assume a client has a Traditional IRA with a balance of $90k, down from its earlier balance of $100k. If the client is in a 32% tax bracket, performing the Roth conversion at the market downturn will result in an estimated tax savings of $3,200, as the client would be making an estimated tax payment on a lower overall balance (32% tax payment on $90k as opposed to $100k). Then, once the money is inside of a Roth account (provided the account has been open for five years and not touched until 59.5), all growth and distributions would occur completely tax-free. Performing the Roth conversion while the market is suppressed allows all market recovery to occur in a tax-free environment (Roth IRA), as opposed to an account that will eventually be taxed at your ordinary income rate upon taking distributions (Traditional IRA).

Funding Roth IRAs/Backdoor Roth IRAs

For much of the same reasoning above, it is generally advantageous to fully fund your annual Roth IRA contribution ($6,000 if under the age of 50, $7,000 if over 50) during a market downturn.

Investing Excess Cash

Generally, we advise clients to keep six months of expenses completely liquid and available for their emergency fund. Let’s assume monthly expenses are $5,000, so a $30,000 emergency fund would suffice in this example. If a client has $100,000 of cash on hand, we would generally recommend investing $70,000 into the market, particularly into any asset class that has seen a double digit pullback. Assuming this is money earmarked for mid and long-term goals, we’d advise investing the excess cash to allow the money to better work to help clients achieve their financial goals.

Selling Fixed Income and Purchasing Equities Within Investment Portfolio

Our general philosophy on having fixed income exposure is that we want our clients to have seven years worth of spending needed in retirement held in fixed income instruments to avoid the risk of receiving lower or negative returns early in a period when withdrawals are made from an investment portfolio. For example, if a client needs $100,000 pulled from their portfolio annually to maintain their lifestyle, we’d advise the client to have $700,000 of their portfolio in fixed income instruments like bonds, cash, or cash value inside of a life insurance contract to help weather market volatility in the distribution years. With this principle in mind, if a client has more than seven years worth of distributions in fixed income, we’d generally advise to sell out of any excess fixed income positions and purchase equities at a discount.

Before implementing any of the above points, it is worth consulting with a financial and tax advisor to ensure that any action steps are fully in line with your financial plan.

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Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.

Stock markets are volatile, and the prices of equity securities fluctuate based on changes in a company’s financial condition and overall market and economic conditions. Although common stocks have historically generated higher average total returns than fixed-income securities over the long-term, common stocks also have experienced significantly more volatility in those returns and, in certain periods, have significantly underperformed relative to fixed-income securities. An adverse event, such as an unfavorable earnings report, may depress the value of a particular common stock held by the Fund. A common stock may also decline due to factors which affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry.  For dividend-paying stocks, dividends are not guaranteed and may decrease without notice.

Past performance is no guarantee of future results.  The change in investment value reflects the appreciation or depreciation due to price changes, plus any distributions and income earned during the report period, less any transaction costs, sales charges, or fees. Gain/loss and holding period information may not reflect adjustments required for tax reporting purposes. You should verify such information when calculating reportable gain or loss.

This content has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment advice or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any matter contained in this document.  The tax and estate planning information provided is general in nature.  It is provided for informational purposes only and should not be construed as legal or tax advice.  Always consult an attorney or tax professional regarding your specific legal or tax situation.