While no one likes a bear market, clever investors may have some opportunities amid the current downturn. Lower prices on certain holdings could allow you to lower your tax liability and may present a great opportunity for investors with extra cash.
Here are three things savvy investors can do to take advantage of this bear market.
1. Tax loss harvesting
A lot of the investments you made in 2021 or earlier in 2022 may be showing a loss on paper. While the market is down 20% from its peak at the start of the year, some stocks are down much more. If you happen to be holding shares of some of those companies, it may be an opportunity to take the loss on those shares.
When you realize a loss, you can use it to offset your capital gains in other investments. If you don't have enough capital gains this year to offset, you can offset up to $3,000 of regular income. Any additional losses are carried forward for future years.
There are a few things to be aware of, though. You can't sell and immediately repurchase shares of the same security. That would violate the wash-sale rule, which nullifies capital losses if a substantially identical security is bought back within 30 days of its sale. You can, however, buy a stock in the same sector or that exhibits similar characteristics.
Even if you're just an index fund investor, you likely have some opportunities to harvest losses. It can be much easier if you like broad-based index funds, like one tracking the S&P 500 and one tracking a total stock market index. Selling one and buying the other is usually considered above board in terms of the wash-sale rule.
The main tenant of tax loss harvesting is that you can offset gains and income today and retain more capital for investing. Ideally, you can keep taxes on your income and capital gains lower in the future, as well.
2. Roth conversions
If you have a lot of assets in your pre-tax IRA, now may be an opportune time to make a conversion to a Roth IRA. By choosing to pay taxes on your assets when they've fallen in valuation, you can lower your tax bill. Withdrawing the same assets six months ago would've cost you more than 20% more in taxes.
An ideal time for many people to make a Roth conversion is early in retirement when your income is very low. Alternatively, if you're facing a gap in your career or a reduced income, it also presents an opportunity to convert at a lower tax rate.
Ultimately, getting more assets into your Roth account at as low of a tax rate as possible provides you with several advantages. First of all, the funds will continue to grow tax free and you'll be able to withdraw funds tax free in retirement. Theoretically, you'll see greater appreciation in the account after the recent downturn.
Second, you'll be able to withdraw the converted funds, if you so choose, after five years without any taxes or penalties, regardless of your age. That's not advised unless you've retired early or truly have an emergency. Once you withdraw funds, you typically can't put them back in.
Finally, Roth IRAs aren't subject to required minimum distributions. As such, you can substantially lower your tax burden later in retirement when faced with both required minimum distributions and Social Security income.
3. Increase savings and investments
When the market puts stocks on sale, it's time to go shopping. As Warren Buffett said in his 2009 letter to Berkshire Hathaway shareholders, "When it's raining gold, reach for a bucket, not a thimble." If you have additional cash or income you could be putting into the stock market, now may be the time to deploy those savings.
If you invest with a long-term time horizon, any pullback in the market increases the expected long-term returns for your investments. Use that knowledge to provide assurance that putting money to work now is a good decision.
There's no need to fear a bear market. If you consistently invest your money year after year, you're bound to experience a few. While each one is different, each presents certain opportunities for investors. Be sure you take advantage of this one as best you can.