Last week, we shared some charts and statistics to help you calm down emotionally during the market meltdown. This week we will talk about some opportunities and strategies you could consider logically.
1. Reevaluate your risk profile.
It is a great time to reevaluate your risk profile. Take the same risk tolerance questionnaire you did before when the market was up. If the result is dramatically different now, it either means that you need to have better self-awareness of your actual willingness to take a risk or you need to get a better questionnaire. If the result is relatively consistent and you still feel panic and worry about your goals, you may want to reevaluate your ability or capacity to take risks and the amount of risk required to take to achieve your financial goals. Once you have a better understanding of your risk profile, adjust your investment accordingly.
2. Harvest some losses in your taxable accounts.
Many people do not like to sell their investment at a loss, which is understandable but non-logical. However, it can sometimes generate some tax benefits by doing so. It is what we called Tax-Loss Harvesting (TLH). I will not get into the basics here, which you can easily find it online. I just want to remind you of two things. The first one is to watch out the wash sale rule. If you are not sure about if replacing one security with another one would trigger the wash sale rule, do not use that security and find another security instead. The second one is to make sure that you understand TLH only defers taxes. In other words, it may or may not make sense based on your specific tax situation now and in the future.
3. Rebalance your portfolio.
Rebalancing is probably one of the most commonly known concepts in portfolio management. Many people are doing it without even noticing through the target-date funds in their 401k. When you rebalance your portfolio during a time like this with such high volatility, two things worth mentioning here. Firstly, reevaluate your rebalancing strategy. For example, if you are using calendar-based rebalancing, see if you can benefit from switching to a tolerance-band based approach temporarily. If you are currently rebalancing based on a tolerance-band, consider if it makes sense to increase your tolerance-band to avoid rebalancing too frequently. Secondly, if you are using ETFs in your portfolio, watch out the spread between the market price and the NAV, especially for those bond ETFs. You may not want to sell something at a price that is a lot lower than it is worth. In other words, you may consider rebalancing your portfolio later or invest some new money to rebalance.
4. Accelerate your savings
For people who understand that volatility is part of the market and the concept of the market cycle, they are not panic at all. They feel excited, and the only question they have is how to invest more in the market and when. Everyone wants to know when the market reaches the "bottom," but in reality, no one could predict the future, and timing the market is a loser's game. In my opinion, if you are still in your asset-accumulation phase with a goal having a long-term horizon to invest, it doesn't matter much to you. Just like shopping for other things, when you see a 10% discount on one thing that you are buying it regularly, are you going to wait and hope you can get a 20% discount in the future? Probably not. You probably will buy a little more at a 10% discount than you usually buy. The logic is the same when it comes to investing. You have been and continually adding more and more money into the market regularly through your 401k contribution, IRA contribution, and other savings regardless of the "price" of the market. Why? Because you believe the market will get even higher or more "expensive" than ever before in the long run. Otherwise, you shouldn't invest like that in the first place. Now you have a chance to get a 30% discount. Why are you waiting?
Having said that, I'm not saying that you should invest more aggressively now without considering your risk profile we mentioned early or dump all your additional money or future savings into the market together. Your investment plan should always be determined based on your specific situation. For example, assuming you want to take advantage of the current discount but not sure if there are higher discounts on the way, you may want to consider creating a plan to buy it gradually. You could consider increasing the percentage of your 401k contributions now. This will let you put the total amount of your originally planned 2020 contribution into your 401k quicker. You could also start making your 2020 IRAs and HSAs contributions and investing it accordingly rather than wait until 2021.
5. Do Roth conversion.
I'm a firm believer in tax diversification. In other words, I believe people should take advantage of taxable accounts, tax-deferred accounts, and tax-free accounts together rather than only using one of them or two. Why? Because you will never know what's the future tax rates will be, and you should be prepared with every possibility and be able to take advantage of any opportunities along the way.
If you have tax-deferred accounts like traditional IRAs and pre-tax 401k accounts still with your old employer, you can choose to pay taxes now and convert some or all of the money to a Roth IRA in any given year. In general, it may make sense to you if you expect you will be in a higher tax bracket when you need to take out the money, or you expect you will temporarily fall into a lot lower tax bracket this year for any reason. Also, make sure you have enough outside savings or cash flow to cover the taxes. In the end, it always depends on your specific situation, especially when it comes to determining how much you should convert. Once you decide how much approximately you should convert this year, consider taking advantage of the recent market meltdown in terms of the timing of your conversion as well. The more you lose, the fewer taxes you need to pay. For example, the value of the investments in your traditional IRA has dropped from $10,000 two months ago to about $7,000 today. Instead of paying taxes on $10,000, you only need to pay taxes on $7,000 if you convert it now. Also, if you invest the same investment in your converted Roth IRA and it grows back to $10,000 again in the future, you don't have to pay any taxes on the $3,000 gain, either.
6. Refinance with caution.
Many people are looking to refinance their mortgage after the Fed cut target interest rate to almost zero. However, the mortgage interest rate is also driven by market supply and demand. When a lot of people are shopping for a lower rate, many lenders may not need to lower their rates further. I won't be surprised if you find some lenders even raiser their rates to reduce the demand since they can't handle more loans. Based on your specific location and situation, you may find a better deal by waiting and keeping yourself informed along the way until the mortgage market becomes more stable.
7. Sell your recent and upcoming stocks purchased through ESPP.
We are only talking about tax-qualified/Section 423 ESPPs here. During good times, the market price of your employer's stock at the purchase date is usually higher than the price at the start date of the offering period defined in your ESPP. If you plan to invest in that stock in the long run, it will be more beneficial to keep the shares you purchased from the ESPP to get favorable tax treatment through the qualifying disposition later. However, when the market is volatile, the market price of your employer's stock at the purchase date can be lower than the price at the start date of the offering period. In this case, even if you still want to invest in the stock for many years, you may want to consider selling the shares now and then buy it back later from the tax perspective. By selling it now, you would only need to pay ordinary income tax on the difference between the market price at the purchase date and your purchase price through a disqualifying disposition. Otherwise, you will pay ordinary income tax on the discount based on the market price at the start date of the offering period when you sell the shares a few years later at a higher price through a qualifying disposition, which is higher in this case.
If you are not familiar with or forget about how the tax treatments on ESPPs works, feel free to get a refresh by reading my blog post, “5 Things You Need To Know About Your ESPP”.
8. Have some play money
First of all, my definition of play money is that money that you can afford to lose. In other words, if you lost every single penny of your play money, none of your short-term or long-term financial goals would be negatively affected. Having said that, if you enjoy investing, would like to have more fun, or believe this is once in a lifetime opportunity to make a bet, here are some bets you could consider for your play money.
Buy companies you like to own at a nice discount that you can only find when the overall market is down for a long-term play.
Buy those closed-end funds or ETFs traded at a massive discount of its NAV and hope the spread will come back to normal in the future.
Buy companies, sectors, industries, or even countries that got crashed and hope they will recover in the end.
In terms of the specifics like what, when, and how to buy and sell, it's your call. It's your play money. Do your due diligence and have fun!
Last but not least, if you find none of the things mentioned above makes sense to you based on your specific situation and still wonder what else you could do, maybe you shouldn't do anything. Sometimes doing nothing is actually one of the best things you can do. It's also true when it comes to investing. I hope it helps!
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