Twists, Turns and Taxes

Discerning investors know that volatility comes with the territory. As we all feel right now, U.S. stock indices can experience wide-ranging swings. While not exactly comforting in your retirement years, those who recognize that the zigs and zags for a specified portion of your overall portfolio are par for the course, can harness that momentum and perhaps even use it to save a little on taxes.

Unprepared investors may overreact when volatility rears its ugly head —locking in losses when the market is sliding because one fears losing even more, often missing out on any rebound potential. 

Instead, here are four concepts one may strategically implement throughout the year, not just during times of turbulence.  

Harvest Losses

Strategically use volatility to your advantage. In the right situation, selling assets at a loss, a practice called tax loss harvesting, may prove beneficial. This strategy can help offset taxes on your investment gains. At the same time, you free up capital to reinvest at lower prices.

Consider selling investments that have declined further than you can tolerate and replace them with a similar but not identical security to avoid any wash-sale violations. You’ll remain invested and get a capital loss that can be carried forward for federal income tax purposes if you don’t need it for the current tax year.

Convert

Another option is to convert a traditional individual retirement account (IRA) to a Roth IRA. The value of the assets will be lower during a downturn, so even though you’ll pay ordinary income tax rates, it may be worth doing so on the lower amount in the IRA. Whether this strategy is advantageous depends on many factors, including current and future tax brackets and identified investment time horizons. If converted to a Roth, those assets can continue to grow tax-free.

Donate

When you think of volatility, you may only think of the downside potential, but for every dip, there is a subsequent rally. Eventually, in that case, consider donating long-­term appreciated securities to a qualified charity that accepts them or to a donor-advised fund (DAF) to minimize capital gains taxes. If you donate to a DAF, you’ll get an immediate charitable deduction for the fair market value of the securities (up to the maximum allowed by law). This may help avoid paying capital gains on the highly appreciated securities, reduce adjusted gross income and reduce assets from your estate. Later, the DAF distributes charitable grants in your name, helping fulfill your philanthropic mission.

Play the Long Game

Last, but perhaps most importantly, keep perspective when markets bounce around. While market volatility is inevitable, craft an investment strategy you can stick with and maintain a balanced portfolio. This means rebalancing to bring your financial plan back in line with your original risk tolerance and asset allocation percentages. Effective asset allocation and diversification can broaden your reach in the market and provide a wider safety net during periods of turbulence (up or down). Volatility often affects individual sectors and asset classes differently, so diversifying across various classes, sectors and securities reduces the chance of one narrow decline devastating your overall portfolio. Keep in mind, too, that short-term declines are buying opportunities for those ready to deploy idle cash.

While uncomfortable, preparing for volatility presents opportunities to rebalance and reallocate to ensure your investments remain in line with your long-term goals. 

Tom King CFP®, CLU®, AEP® is Registered Principal of King Financial Partners, goKFP.com, at 222 Blue Course Drive, State College, PA. King Financial is a team of credentialed professionals specializing in retirement, investment management, wealth transfer and estate planning. Tom can be reached at Tom@goKFP.com or (814) 234-3300.

There is no assurance that any investment strategy will be successful. Investing involves risk including the possible loss of capital. Sources: Raymond James Worthwhile Spring 2020.  Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC.© 2021 Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. King Financial Partners is not a registered broker/dealer and is independent of Raymond James Financial Services.