The stock market has been on a roller coaster lately. When this happens, some investors decide to get off the ride, but that isn't always the best option. Instead of getting out of the market, there are several smart money moves to make when the stock market is volatile that can actually improve your chances for financial success.
Note: We are not professional investment advisors and this article does not contain investing advice. The stock market is inherently risky and there is always a chance your investments could decrease in value.
Call your advisor (if you have one)
Many people think a financial advisor is there to provide stock picks and insider information to make you rich. That's not the case. Financial advisors help you develop your investing strategy and act as a sounding board to keep you on track.
During volatile market times, financial advisors can become even more important. They can act as the voice of reason when your emotions might get the best of you. They can calm your nerves and remind you of your goals.
Here are a few questions you may want to ask your financial advisor:
- How does the current market volatility affect my retirement goals?
- Do my current investments still make sense for me?
- If I make any moves, will they affect my taxes? If so, how can I minimize my taxes?
For people who don't have a financial advisor, now may be the time to reach out for some professional advice. Although many financial advisors get paid from sales commissions or as a percentage of your portfolio; others simply charge a flat fee. Utilizing the services of a flat-fee financial advisor can be a great money move for do-it-yourself investors who need only periodic checkups or advice on specific topics.
Increase your contributions
Many people consider investing during a recession to be a bad thing. But unless you need the money right away, buying more when the market goes down can actually improve your retirement scenario.
Increasing your regular contributions to your 401(k), IRA, or another investment account can take advantage of something called dollar-cost averaging. Dollar-cost averaging is the regular investment of a set amount of money over a long period of time. Basically, when the market goes up, your set amount of money buys you fewer shares, and when the market goes down, that same amount of money allows you to buy more shares. Over time, your average cost to buy will be lower.
For example, let's say you invest $100 a month for three months. The shares you bought in the first month cost you $10; they cost $5 in month two; and they cost $20 in month three. This means you'll have purchased 10, 20, and five shares respectively for a total of 35 shares. Although the investment is now priced at $20 a share, your average cost to acquire those shares was only $8.57 each.
|Money invested||Price per Share||Shares purchased|
|Total invested: $300||Average price per share: $8.57||Total shares purchased: 35|
Most people are not able to increase their contributions significantly right away. If you have a company retirement plan, you could try to increase your contributions by 1% every six months until you max out your allowed contributions or get to your ideal contribution level. For individual IRAs (Roth or Traditional), you might increase your monthly contribution by $25 every three to six months.
These are the 2022 contribution limits for some common types of retirement accounts:
|Contribution limit||If you are 50+ years old|
* SEP-IRA contribution limit is lesser of $61,000 or 25% of compensation
For people who are not yet taking full advantage of their company's retirement match, a volatile market presents an excellent time for a double win. Not only will you be contributing more money for your future, but your employer will also be adding more as well.
For example, say your company offers a 1:1 match up to 6%. This means your company will match your retirement contributions up to 6% of your salary. If you're contributing 3% to your 401(k) and bump it up 1%, both you and your company are now contributing 4% to your retirement, for a total of 8% of your salary. This means you have the potential to buy into even more investments at a great price while the stock market is down.
Convert your Roth IRA
Roth IRA conversions are a popular investment strategy because you are converting taxable money in your Traditional IRA into tax-free money in your Roth IRA. The problem with these conversions is that the IRS treats it as taxable income. Depending on your income and tax bracket, this additional income could boost your taxes by quite a bit.
However, when the stock market goes down, it’s a perfect time to initiate a Roth IRA conversion. Instead of your stock or mutual fund being worth $100 a share, it might only be worth $60 a share. This means the taxes you owe on the conversion could be substantially less.
This is a great strategy for people with a higher income that cannot otherwise contribute to a Roth IRA. The IRS determines your allowed Roth IRA contributions based on your adjusted gross income, your marital status, and how you file your taxes. For example, if you're married and filing jointly and your combined AGI is $214,000 or more, neither of you can contribute to a Roth IRA. But with a Roth IRA conversion, how much money you make is not a limiting factor. This is why this strategy is so popular with people who can afford to pay the taxes on the conversion.
Here are some examples of situations where a Roth IRA conversion makes sense:
- You expect to be in a higher tax bracket in retirement than you are now.
- Your income is lower this year than normal.
- The value of your IRA investments has temporarily declined.
- You have other losses or deductions to minimize the taxes due on the conversion.
- You won't need to take the mandatory minimum distributions at 70 1/2 as required by a Traditional IRA.
- You're moving to a state with higher income taxes.
Rebalance your portfolio
When you start learning how to invest money, your contributions are added to your portfolio according to the percentages you choose. You'll typically choose investments based on your risk tolerance, goals, and time frame for investing.
For example, someone may have originally chosen a mix of 40% S&P 500, 20% small cap, 20% international, and 20% bonds for their company retirement account. However, over time, the portfolio will most likely not resemble those same percentages because each of these investments will perform differently. Due to market performance, the ratios could end much higher or lower than you originally intended.
One of the ways to fix that is to rebalance your portfolio to bring your investments back in line with your desired allocation. This allows you to sell the winners (those that went up in price) and buy the losers (those that went down). When you sell investments that have gone up in value that pulls some profits off the table. Then, you can take your profits and buy more of the investments that are now on sale.
|Year 1||% of portfolio||Year 2||% of portfolio||Reallocated||% of portfolio|
Don't let the language fool you. The investments you've chosen aren't really winners or losers. They just happen to represent different classes of investments that are designed to get you to your goals.
Although rebalancing your portfolio is a good thing, most experts agree you should not rebalance too often. There are two primary strategies to consider when rebalancing your portfolio so pick which one is likely to work best for you:
- Rebalance when an asset's portion of your portfolio changes by more than 5% (e.g. increases from 15% to 20% or goes from 15% to down below 10%)
- Rebalance once a year on a set date (e.g. every year on your birthday)
For investors who are already in target-date funds or balanced funds, your investment managers will actively perform rebalancing on your behalf to stay near your target investment allocation.
Harvest losses for taxes
As investors, we like it when investments go up in value. This makes us money and gets us closer to our investment goals. However, when investments temporarily go down in value, this provides an opportunity known as tax-loss harvesting.
Tax-loss harvesting is a strategy to reduce your taxes by intentionally selling investments at a loss when they are temporarily down in value. This may be done as part of your rebalancing process, as a shift away from a certain investment, or as a temporary sale with the intention to repurchase the same investment at a later date.
When you sell investments for a loss, you’re able to write off those losses against your taxes. Federal law allows for tax losses to be written off against gains dollar for dollar. Tax laws also allow you to write off up to $3,000 per year in investment losses in excess of any gains.
Here are two scenarios to show how taking advantage of tax-loss harvesting works:
- Sarah sells an investment for a loss of $4,000. She sells another investment for $5,000 in gains. The losses reduce the gains, so she'll only need to pay taxes on $1,000 of net gains.
- Johnny sells an investment for a loss of $5,700 and doesn't sell anything else. He can write off $3,000 this year against his income. The remaining $2,700 can be carried forward to the next year to offset future gains or reduce taxable income.
If you still like the investment that you sold, you can buy it back. However, you need to be aware of the 30-day wash rule. To reduce investors taking advantage of tax laws, the 30-day wash rule prohibits you from deducting losses if you buy another investment within 30 days that is substantially the same as the one you sold.
For example, if you sell the Fidelity S&P 500 index fund and buy the Vanguard S&P 500 index fund, those are substantially the same investment. However, if you sell the Fidelity S&P 500 index fund and buy a small-cap index or an international fund, then those would be materially different.
If you wait 31 days and buy the same investment you just sold, you are eligible to write off the losses. However, it is recommended that you wait an extra few days before buying again to give yourself a safety buffer. And keep in mind that you will be out of the market during this time so you could miss out on any gains this investment may have had during that time frame. Depending on the timing of this gap, the impact could be significant.
Note: The 30-day wash rule is relevant for investors making trades only within a taxable brokerage account. For investors who are making moves within a tax-deferred retirement account, such as a 401(k) or traditional IRA, the 30-day wash rule doesn't apply.
Switch to lower expense investments
When you're evaluating your investments, you should also look at your fees. Lowering your fees by switching from one platform or investment to another is an easy way to boost your performance without taking on any additional risk. Many companies have reduced or eliminated trading fees on stocks, mutual funds, and exchange-traded funds.
Also, take a look at the annual fund expenses for your current investments. According to the National Association of Plan Advisors, the average actively traded stock mutual fund had an expense ratio of .76% in 2018; the average index ETF ratio was 0.20%. If your investments are charging higher expenses, are you getting more from that expense?
If the answer is no, then this may be the right time to switch from an actively managed fund to an index mutual fund or ETF. Or you can move from a company that charges higher fees to one that charges less. For example, if identical investments focus on the S&P 500 and one charges .25% and the other charges .03%, you'll have the potential to earn an extra .22% each and every year by switching to the less expensive option.
Build your emergency fund
Some people feel uncertain about a volatile stock market and stop investing. But instead of just spending that money elsewhere, you should bulk up your emergency fund instead. This keeps you in the habit of putting money aside for the future and provides an extra cushion in case the economy turns for the worse.
It is a good idea to have three to six months of expenses in a liquid emergency fund. Having this pool of money could be especially important if you believe we should be preparing for an imminent recession. Most people use a high-yield savings account or CDs (certificates of deposit) to earn a bit more interest on their money. When you feel more confident about the economy, this extra money can stay in your emergency fund or be used to strategically invest a lump sum of cash.
The big advantage of this strategy is that it ensures you don't experience lifestyle creep. Lifestyle creep happens when you suddenly have a bit of extra money and start to spend it on things you otherwise wouldn't. You may start to eat out more, splurge on clothing, or get into additional debt. Once you go down the path of spending, it can be difficult to scale back. So instead of taunting yourself with money that used to go into the stock market, consider putting that cash into an online savings account instead.
When the stock market is volatile, it presents a unique opportunity to improve your financial situation. Yes, it can be a scary or emotional time when the market goes up and down like a roller coaster, but making smart money moves has the potential to boost both your confidence and your portfolio.
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