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4 Ways to Ease the Bear Market’s Pain

Bear markets are just part of investing. Here’s how to make the best of it

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Plunging stock prices in a bear market can leave a sour taste in the mouth of retirees who rely on their investments to help fund their lifestyle. But instead of bailing out of the stock market at the wrong time or wallowing in your financial misfortune, a better strategy is to turn a lemon market into lemonade. “There are a few things investors can do to take advantage of potential opportunities in a down market,” says Brian Walsh, senior manager of financial planning at online financial company SoFi. 

What you don’t want to do is panic and harm your long-term finances by making portfolio moves driven by fear and emotion that will put you deeper in a hole, says Jerry Braakman, president and chief investment officer at First American Trust. What’s past is past. Your job is to minimize the damage of the market downturn and look ahead. “You want to position your portfolio for the market’s next phase,” Braakman says.

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Remember, bear markets eventually end. History tells us that stocks do eventually recover.

In the post-World War II era, the 10 garden-variety bear markets, or ones in which the S&P 500 stock index declined 20 to 40 percent, have lasted an average 10 months and brought average declines of 27 percent. More importantly, the market has typically fully recovered in 14 months, according to data from CFRA Research.  

So, what’s an investor to do?

1. Buy stocks on sale

A bear market marks down stock prices from expensive to cheap. At the bear market low in mid-June 2022, for example, the S&P 500 was down nearly 24 percent from the start of the year. And that Wall Street discount amounts to a big sale, no different than massive markdowns during Black Friday holiday sales.

So, avoid selling stocks at depressed prices and locking in losses. Instead, consider buying shares of beaten-down quality companies that sell popular products. You’ll be taking advantage of lower prices and the eventual rebound, says Falko Hoernicke, senior portfolio manager at U.S. Bank Private Wealth Management. “You’ll probably find some hidden treasures,” Hoernicke says.

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But don’t buy clunker stocks on sale. Instead, buy shares of companies that are number one or number two in market share in their line of business and have pricing power that enables healthy profits to keep rolling in, Hoernicke adds.

2. Consider a Roth IRA conversion

With stock prices depressed, now could also be a good time to convert a traditional IRA or qualified employer-sponsored retirement account. Those accounts were funded with pretax dollars and require you to pay taxes on withdrawals. The benefit of the Roth is you’ll pay zero taxes on withdrawals for life, provided you don’t tap the account for five years. You’ll also avoid having to pay required minimum distributions (RMDs) during your lifetime (regular IRAs make you take RMDs starting at age 72). Another plus is you will be able to pass on tax-free assets to heirs.

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The catch? You’ll have to pay taxes at your ordinary income rate on the dollar amount you convert to the Roth IRA.

Doing a conversion in a down market can make sense, mainly because the dollar value of the IRA is now lower due to the stock market decline, which means you’ll pay less taxes on the conversion than you would when stock prices were higher at the market peak.

Let’s say, for example, you want to convert your entire IRA balance — now valued at $100,000, down from a pre-bear value of $125,000 — to a Roth. You’ll benefit in two ways. First, your tax hit will be lower because your account will be $25,000 lower. Second, you’ll be moving the same number of shares despite the loss in the IRA’s value, which means you’ll be better able to take advantage of the market rebound. “When the recovery comes, all your shares will be inside a tax-free account,” says Tim Steffen, director of tax planning at Baird, a money-management firm. And the more shares you convert now into the tax-free Roth IRA, the bigger potential payday you can get years down the road when those share prices appreciate under the Roth umbrella.

A Roth conversion works best, according to Wells Fargo, if you won’t need the money for at least five years, as IRS rules forbid tax-free withdrawals until at least five years after you first contributed to the account. A Roth makes most sense if you expect to be in the same or higher tax bracket during retirement. It’s also better if you have available cash to pay the tax bill without using the IRA funds, as you want as many shares as possible in the IRA to benefit from future growth.

Wells Fargo says a Roth IRA conversion makes less sense if the dollar amount being converted pushes you into a higher tax bracket in the tax year that you do the conversion, or if you think you will be in a much lower tax bracket when you retire. The tax benefits of a Roth IRA are also less impressive if you live in or plan to relocate to a state with no or lower state income tax.

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3. Sell losing stocks to lower your tax bill

Sure, it’s a drag when your stock investments decline in value and are now worth less on paper than when you bought your shares. But the fact is portfolio losses do have some value, and they are especially valuable when it comes to trimming your tax bill.

Bear markets are a good time to do some tax-loss harvesting, says SoFi’s Walsh. Simply put, it’s when “you turn paper losses into real losses in order to save money on taxes,” Walsh says.

When you sell your lemon stocks, you can use the losses to offset taxable capital gains incurred from your winners. And once you’ve used losses to offset all your capital gains, you can also use losses to offset up to $3,000 of ordinary income on your tax return. And if you still have losses left over, you can carry over those losses to future tax years.

Let’s say you have a $20,000 gain on energy stocks in 2022, but you have $25,000 losses on hard-hit technology stocks. If you sell your winning energy stocks, you can use the $25,000 in losses to offset your $20,000 gain. You can offset $3,000 of ordinary income. And you can carry over the leftover $2,000 in losses to future tax years to offset gains.

4. Rebalance your portfolio

Now’s not the time to treat your portfolio in a willy-nilly fashion. It’s time to be disciplined. And that means making sure your portfolio’s mix of stocks and bonds doesn’t get too out of whack due to market gyrations. Even though your financial plan calls for 60 percent stocks, the bear market might have trimmed your stock holdings to just 50 percent of your portfolio.

So now’s the time to sell other assets in your portfolio that now make up a larger chunk of your holdings and buy beaten-down stocks to get your stock allocation back up to 60 percent. “Portfolio rebalancing,” says SoFi’s Walsh, “can generate long-term improvements” in your returns. “You are selling out of investments that are winners and buying into losers. So you are buying more shares of investments that are down in price and that can help your money grow over a long period of time.”

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