We expect most people have a grasp on how to make money in a bull market, but it can be far more challenging to contemplate how to make money during a bear market, when emotions are running high. It’s not all about making money, though. Some of it involves figuring out how to put oneself into a better financial position for the future so that you can heal faster from the losses. There are a handful of key strategies to engage in during a bear market that will help your finances as much as your future, and one of the most important of these is ROTH conversions.
Believe it or not, bear markets represent the best environment into which to make an IRA-to-ROTH conversion. The more negative the equity losses are, the more attractive the conversion becomes. When making a conversion to ROTH, you can either move cash or you can move shares of the stocks or mutual funds that you own in the IRA. When we make a conversion, we choose to move shares for our client families. The tactical benefit here is that we actually get to pick the specific funds to move from the IRA to the ROTH. Whichever funds have the deepest losses for the given year are the ones with the highest priority to move over first.
Think of it this way: if we found ourselves in a sharp bear market, we would expect several equity asset classes to be down, but maybe inside our IRA the US small cap fund went down the most with a -35% loss. Although it may not feel like it, bear market losses are temporary, so it is important to take action and make the conversion to the ROTH while the markets and the news are negative and remain temporarily distressed. If we were to hypothetically move $50,000 of the US small cap fund in our example, we would actually be moving shares that were previously 35% higher in value at $77,000. If we convert the $50,000 of small cap shares right now, we incur the tax liability on those shares on the day they are moved over. Once the shares have arrived in the ROTH, it then becomes a matter of exercising patience. It might take six or nine months for the current bear market to pass; but when the economy improves, those distressed shares should bounce back in value. In a relatively short number of months, the $50,000 that was converted and that you paid tax on might be worth $65,000 or $70,000—but remember, you only paid tax on $50,000. Much like a spring being compressed and then subsequently released, the idea behind the conversion is to move the shares to the ROTH while the spring is compressed. Simply put, the bear market represents a tax-savings opportunity in disguise, so acting now is highly important BEFORE things improve in society. Effectively, ROTH conversions and bear markets coupled together give us a way to legally cheat the IRS out of tax dollars.
The benefits of ROTH conversions are not just effective during a severe bear market but can be utilized nearly every year. If you employ a highly diversified portfolio with multiple asset classes held in your IRA and ROTH, there are lots of opportunities to take advantage of the up and down stock market movements, as many asset classes move at different rhythms. There are a host of financial planning advantages to ROTH accounts and gradually converting IRA money into ROTH each year. Keep in mind, ROTH accounts contain post-tax money; they do not have required minimum distributions, which do apply to traditional IRAs; and all of the future growth on the assets in the ROTH are considered post-tax. All withdrawals from ROTHs are voluntary, and all of the dividends, interest, and earnings in the ROTH are shielded from taxes. Another advantage of a ROTH account is that it can be viewed with your IRA using an overall investment approach that we call Asset Location. Essentially, Asset Location seeks to view the IRA and ROTH accounts as if they were one account holding one investment portfolio but divvies the funds between the accounts to the greatest advantage. Reach out to your advisor if you are curious about conversions and ROTH accounts and learn more about how we advocate for our families.