By: Brad Griffith, CPA, CFP®, CRPC® - Financial Planner
During times of market volatility, our team at Buckingham Advisors works diligently to identify opportunities to implement tax and financial planning strategies. While it can be very distressing to see account balances go down, it’s important to remember that stocks/equities are long-term investments, and pull backs and moments of fear are a part of economic cycles. In this article, I want to cover some basic financial planning principles to ease anxiety and discuss a few more advanced planning strategies to consider.
Before considering investing, our team’s first suggestion is to have a minimum of 3-6 months of living expenses in liquid cash to cover emergencies as they come up. This is money set aside to pay for water heaters, furnace, AC, roof, or extended time out of work. This helps avoid turning to high interest rate credit cards to pay bills. Check with your bank about a money market fund or higher interest rate savings account. This is your personal insurance policy for emergencies such as time off work.
Safety Built into Your Portfolios
Our financial planning team works closely with our Investment Department to come up with an appropriate investment allocation based on your goals, time horizon and risk tolerance. You probably remember taking a Risk Profile Questionnaire and/or discussing your long-term goals with your advisor to help guide this allocation. One of the main objectives of this allocation is to help keep enough in fixed income investments to last you anywhere between 3-10+ years of your cash needs. For example, let’s say you have $600,000 invested in your retirement account in a 60% stocks/40% bonds allocation and are taking $2,000 in monthly distributions. You have $240,000 in cash/bonds to meet your income need. Assuming no interest, that $240,000 will last you 120 months (or 10 years!) to get you through these pull backs. The other $360,000 in equities will be in for a bumpy ride like we are seeing now; but historically over time, stocks have significantly outperformed bonds/cash.
One of the key benefits of actively managed accounts is that there is regular rebalancing. Let’s say your appropriate stocks to bonds allocation is 70%/30%. In years where stocks do well, your allocation might have gotten up to 75%/25%. As a part of our regular rebalancing, we trimmed back to the 70%/30% target by selling stocks that did well and move more into bonds. During this volatility, your allocation might be closer to 60%/40%. When they determine its appropriate, our investment team will start to use some of the cash to purchase stocks at these lower levels to get you back to the 70%/30% target. This is the forced discipline of selling high and buying low!
With the recent market pull back, this could be a great time to get cash to work for long term investing in your IRAs. This could help you save money in taxes today or at retirement. There are complicated income limits to making Roth and Traditional IRA contributions, so make sure you check with your financial planner to see how much and what type of IRA contribution might make sense. The IRS announced that the extension of the due date for 2019 IRA contributions to be the same as the new tax return due date of July 15, 2020.
Roth Conversions & Investment Allocation Changes
It is important to consider Roth IRAs in your retirement plan since the entire account can be used tax free in retirement. This helps hedge against higher future tax rates. While there are income limits to contributing to Roth IRAs, there are a few work arounds to get money into a Roth IRA. One way to do that is through Roth conversions. This involves moving money from a pre-tax IRA to a Roth IRA. While the conversion is taxable, the balance is likely lower now, and all future growth is tax free! With the market down, this could be a great opportunity to capitalize on that tax-free growth when the market recovers. If you are expecting income to be lower this year with reduced work, it might also be an even better opportunity since you may be in a lower tax bracket.
Along those same lines, this is a great time to look at increasing your stock/equity allocation in your longer-term investment accounts, such as your Roth IRA, and dialing back the equity exposure in your tax deferred accounts. Overall, you are not increasing or decreasing risk but taking advantage of tax-free growth in the Roth and minimizing future taxes in your pre-tax accounts.
Tax Loss Harvesting & Trimming Oversized Positions
Our financial planners and investment team are working closely to look for opportunities to “harvest losses” in your taxable investment accounts and then reinvest the proceeds into other stocks. These losses can be used to reduce taxable income by up to $3,000 per year or offset against future gains.
It is also a good time to start trimming back oversized positions that might have become large due to significant unrealized gains. Our investment team usually suggests limiting individual stock position sizes to less than 3% of investable assets to be well diversified.
Mutual Funds in Taxable Accounts
If you have mutual funds, especially in taxable accounts, it is a good time to consider moving to Exchange Traded Funds (ETFs) or individual stocks, which can still be appropriately diversified. In addition to often having high or confusing fees, mutual funds are difficult to plan around, because they pass out gains every year based on what the internal fund manager buys and sells. Gains are not reported until February of the following year, making it almost impossible to do tax planning. Many mutual fund holders will be surprised to see mutual funds pass out large capital gains even with the market going down. Choosing the right mix of ETFs and individual stock make tax planning much easier, which in turn saves you money!
If you are a current client, we are already addressing these strategies when and where they make sense; but please do not hesitate to reach out to us with questions or updates regarding your specific situation.
If you are not a client (or have investments outside Buckingham Advisors), and your current advisor is not discussing these strategies, we would love to set up a time to talk about how this is the perfect time to start implementing some of these advanced planning techniques.Please share with your friends, family, and colleagues who might be able to benefit! We realize there is a lot of information here, but we wanted to let you know that we are working diligently to implement these strategies and during volatile market situations.