News continues to move quickly regarding covid-19, and it feels like so many things are out of our control. However, now is not the time to be making drastic changes to your investments without a professional. I understand the fear of seeing wild swings in the stock market, and I understand the deep need to feel like you’re doing something, taking action, or putting in place some protections for yourself. Start by naming what you’re feeling as a first step.
Then, instead of taking some action you may regret later, focus your efforts on reaching out to a professional, spend some time doing academic research about stocks, and look at historic trends which show that recoveries typically take months, not years when we see market downturns. One book that is great at putting things in perspective is “A Random Walk Down Wall Street.”
The one action you’re allowed to take (assuming you trust the research you’ve done on your investment selections to begin with) is to login once to your retirement account and hit the “rebalance” button. Let that be the last time you login or watch your portfolio balance for at least 3 months. It’s best to continue contributing as normal while you get a discount as your monthly contributions toward retirement auto-invest.
I recommend against following financial news, since 95% of it is NOT focused on advice for the long-term investor. Don’t believe me? Try this exercise for yourself. Pick any financial news headline (positive or negative). For instance, “Stocks head into rocky territory.” Now search for the exact opposite headline “Stocks showing signs of improvement.” I guarantee you will find the opposite headline published the same day or within a day or so of the first. How can both be right? They are both true if you’re only focusing on the day-to-day market movements instead of the long-term trajectory of the market. In the long-term, we expect growth.
The price of a stock only matters on two days: the day you buy and the day you sell. Not selling and not making changes means you will live to see a higher price some day. Your retirement funds should stay put and you should ride it out.
You can also imagine the pent up demand for products, travel, eating out, concerts, etc. and see quickly how a recovery could take shape faster that we (or recent) headlines would consider at first.
Borrowing From Retirement Should Be Your Last Line of Defense
You may also be tempted to borrow from your 401k or IRA if you have lost your job or are otherwise severely being impacted by contracting covid-19 or taking care of an ailing family member. The CARES act allow people impacted by the coronavirus to withdraw up to $100,000 from their retirement accounts and avoid the typical 10% penalty the IRS imposes.
However, what you may not know or think about right away is the fact that the CAREs act DID NOT waive the taxation of your withdrawal. You will still owe significant state and federal taxes when you remove these funds from your retirement account, and they can be significant. Let’s say you remove the full $100,000 allowed by the CAREs act. You’ll only get to use about $66,000* of the funds. The rest will be paid in state and local taxes (*based on the federal marginal rate of 24% and a state tax of 10%). The more you withdraw, the higher the tax rate you could pay, since you tax bracket is determined by total income for the year. Plus, you’re jeopardizing your ability to retire some day — and American’s are already woefully under-saving for retirement as it is.
This is a high price to pay. Instead of raiding your retirement as a first line of defense, consider negotiating with creditors, banks, and lenders, which have all announced significant relief from everything from credit card interest, to auto insurance, to mortgages.
There are also a number of government programs, including expanded unemployment payments at both the state and federal level (even for contractors and the self-employed) that are attempting to keep people afloat. Consider microloans from state, local and charitable sources. There will likely be new government programs announced. This is the part of the news that you should be paying attention to rather than news about the financial markets.
If you’re stuck, I’m offering free/pro-bono help to people impacted by covid-19. To book a time slot, click here.
Investing Outside of Retirement May Require Other Strategies
It’s impossible for me to provide blanket advice without knowing your exact situation, but I can say that your investments outside of retirement accounts might need different treatment and might warrant some adjustments during the crisis based on tax laws and the latest research on portfolio management. I have gotten the question a lot – is now a good time to invest? It really depends on whether you have an adequate savings buffer. The reason why you are investing also matters because if you’re going to need this money in a few years, it’s probably better to keep it in cash.
For those of you who already have money invested outside retirement accounts, these scenarios apply whether you are a “buy and hold” investor or not. Here are four scenarios that all require different treatment during a crisis.
Scenario 1: You have a diversified portfolio that has investments in stocks and bonds across the entire globe. Stocks make up 80% of the portfolio and bonds make up 20%. Still, some of the holdings have done better than others (that’s what diversification is all about), and now you have about 24% bonds. This portfolio has effectively become more conservative through the market downturn, which means you may be out of line with your financial plan. You might consider selling some of the bond holdings and buying more stock holdings to get your asset allocation back to where you started (80/20).
Scenario 2: You have a diversified portfolio that has stayed in line with your target allocation of 70% stocks and 30% bonds. However, some of the international holdings you own have gone down quite a bit. You can harvest these losses as a way to save on taxes this year, and perhaps in future years in a process called “Tax Loss Harvesting.” This involves selling those positions that have lost money and replacing them with similar funds that hold international stocks. That way you harvest the losses, reduce taxable income, but stay invested in the market. All the while, you are earning dividends and interest which can be reinvested in the market at the current discount rates.
Scenario 3: You own single name stocks that your grandfather gave you years ago, but you’ve been reticent to sell because you know you will owe lots of taxes on capital gains. Now may be a good time to revisit the idea of selling. You can utilize aggressive tax-loss harvesting to offset most, if not all of the gains to prevent an out-sized tax bill. And you can invest the proceeds in a fully diversified portfolio, owing stocks and bonds from around the world, making it more likely that you’ll recover faster than if you stayed in your un-diversified position.
Scenario 4: Your income has increased in recent years and you realized that the interest on the government bond holdings you own has started generating more taxable income than you like. If you take this opportunity to sell your government bond funds (perhaps at a loss), you can use the losses to offset some wage income and capital gains now or in the future. You can also replace those holdings with municipal bonds, which aren’t taxed at the federal and aren’t taxed at the state level (as long as you can find a bond fund that only purchases bonds in your state.)
Hopefully some of these scenarios get you thinking about your options. With investing there are no cut and dry, blanket recommendations I can provide for you since everyone is different. What I can say is that everyone can benefit from a financial plan that will help dictate exactly what to do during a crisis with your investments, savings, and financial goals. If I can be helpful as a sounding board in anyway, don’t hesitate to reach out.