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Taking Tax Advantage

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2 min
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Ashley works with clients to bring strategy, structure, clarity and confidence to their global financial lives and keep it that way. ​In 2013, Ashley founded Arete Wealth Strategists, a fee-only financial planning and investment management firm for Australian/American expatriates.
May 17, 2022

There are always strategies that take advantage of market movements which have nothing to do with market timing.  One of the simplest is periodically rebalancing the portfolio to its original mix of assets.  In a simplistic version of this, you might have a mix of 60% stocks (including international, small and large cap etc.) and bonds (Treasuries, corporates and various maturities), and suddenly the market goes up or down in a hurry.  You have either more than 60% or less than 60% stocks, so you sell or buy back to the original tolerance.  If you’re disciplined about following this process, you will end up selling when the market has gone up (locking in gains) and buying when the market goes down (taking advantage of bargain prices).  

Another, slightly more complicated strategy is Roth conversions.  This basically means taking some of a traditional IRA portfolio and moving it to a Roth account.  Since you didn’t pay taxes on the assets when they were contributed into the IRA portfolio, Uncle Sam requires you to pay ordinary income taxes on the money as it’s moved over.  But once in the Roth, those assets will never again be touched by the government.  Gains and distributions are tax-free, even when the money is inherited.  The Roth owner also doesn’t have to take out required minimum distributions—ever.  (That, of course, doesn’t apply to inherited Roths, but even there the money comes out tax-free.)

Obviously, the best time to do a Roth conversion is right after the stock market has experienced losses, because you can roll over more shares of stocks, funds or ETFs at lower valuations, which means lower taxes than you might have had to pay if the conversion had been made at market highs.  Then, assuming the markets recover, all the future gains will happen in a totally tax-free environment.

The Roth conversion can be made a bit more valuable if, at the same time, due to the same market downturn, you can ‘harvest’ $3,000 worth of losses in a taxable portfolio.  You sell assets that are trading below what you paid for them, up to $3,000 (which is the limit that can be used to offset ordinary income), and use the losses to offset some of the tax impact of the conversion.  

These investment strategies are not nearly as exciting as predicting where the markets are going to go next—which is what the financial press tends to focus on.  But since predicting what the markets will do in the future is a fool’s errand in the first place, the boring approach of taking advantage of what the market offers is not a bad alternative.

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