Market decline

How investors can profit from falling stock markets

While no one likes a bear market, smart investors may actually have opportunities in the current downturn. Lower prices on certain holdings could allow you to reduce your tax liability and can present a great opportunity for investors with additional cash.

There is no need to fear a bear market. After all, if you consistently invest your money year after year, you’re bound to come across a few. Although each is different, each presents certain opportunities for investors. Be sure to take advantage of this one as best you can.

Here are three things savvy investors can do to take advantage:

1. Collecting tax losses

Many of the investments you made in 2021 or earlier in 2022 may show a loss on paper. While the market is down 20% from its peak at the start of the year, some stocks are falling much more. If you happen to own shares of some of these companies, this 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 to future years.

There are a few things to be aware of, however. You cannot immediately sell and redeem shares of the same security. It would violate the void-sale rule, which reverses capital losses if a substantially identical security is repurchased within 30 days of its sale. However, you can buy a stock from the same sector or with similar characteristics.

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Even if you are only one index fund investor, you probably have opportunities to reap the losses. It can be a lot easier if you like broad-based index funds, like one that tracks the S&P 500 and one that tracks a total stock index. Selling one and buying the other is generally considered fair in terms of the fictitious selling rule.

The main tenant of tax loss harvesting is that you can offset gains and income today and retain more capital to invest. Ideally, you can also reduce taxes on your income and capital gains in the future.

2. Roth conversions

If you have a lot of assets in your pre-tax IRA, now might be a good time to convert to a Roth IRA. By choosing to pay taxes on your assets when they have fallen in value, you can lower your tax bill. Withdrawing the same assets six months ago would have cost you over 20% more in taxes.

An ideal time for many people to make a Roth conversion is in early retirement when your income is very low. Alternatively, if you are facing a career gap or reduced income, this also presents an opportunity to convert at a lower tax rate.

Ultimately, getting more assets into your Roth account at as low a tax rate as possible gives you several benefits. First, the funds will continue to grow tax-free and you can withdraw funds tax-free in retirement. Theoretically, you will see greater account appreciation after the recent downturn.

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Second, you will be able to withdraw the converted funds, if you wish, after five years without tax or penalty, regardless of your age. This is not advised unless you have taken early retirement or really have an emergency. Once you withdraw funds, you usually cannot return them.

Finally, Roth IRAs are not subject to minimum required distributions. As such, you can significantly reduce your tax burden later in retirement when you are faced with both required minimum distributions and Social Security income.

3. Increase savings and investments

When the market puts stocks up for sale, it’s time to shop. As Warren Buffett said in his 2009 letter to Berkshire Hathaway shareholders, “When it rains gold, grab a bucket, not a thimble.” If you have extra cash or income that you could invest in the stock market, now might be the time to deploy those savings.

If you invest with a long-term time horizon, any market decline increases the long-term returns expected for your investments. Use this knowledge to make sure putting money to work now is a good decision.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool holds positions and recommends Berkshire Hathaway (B shares). The Motley Fool recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), $200 short puts in January 2023 on Berkshire Hathaway (B shares) and short calls of $265 in January 2023 on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy. The Motley Fool is a USA TODAY content partner offering financial news, analysis and commentary designed to help people take control of their financial lives. Its content is produced independently of USA TODAY.

The Motley Fool is a USA TODAY content partner offering financial news, analysis and commentary designed to help people take control of their financial lives. Its content is produced independently of USA TODAY.