5 surprising benefits when things don’t go according to plan
As much as we might want it to be, investing is rarely a smooth ride. But just because big selloffs and volatility can make investing a little cloudy, it doesn’t mean there isn’t going to be a silver lining. Here are five ways investors can benefit from periods of market correction.
- Employee stock purchase plans. ESPPs are company programs that allow employees to enroll and purchase company stock via payroll deductions. They typically have an offering date (when funds begin to be deducted from your paycheck and put into escrow) and a purchase date (when those escrowed funds are used to purchase the stock). If company stock is selling for $20/share and you’d like to buy 50 shares, then $1,000 will be withheld over the offering period (usually six months, or about $83 per paycheck
The down market advantage: If your company’s stock price decreases over the offering period, then you’re by default purchasing shares at a discount. But many ESPPs also have a lookback provision where you would pay either the stock price on the offering date or the stock price on the purchase date – whichever is less. Moreover, many companies also offer a discount (typically between 1% and 15%) to encourage employee participation, on top of a lookback provision.
- Dollar cost averaging. DCA is an investment strategy where you contribute a fixed amount of money at regular intervals (say, monthly) over a long period of time. If you use payroll deductions to contribute to a 401(k) or 529 education savings plan or if you regularly reinvest dividend payments, you’re already taking advantage of dollar cost averaging.
The down market advantage: Instead of buying a certain number of shares, dollar cost averaging buys as many shares as the market will allow. In a down market, you would end up buying more shares, reducing your cost per share and increasing potential gains in a market recovery.
- Estate planning. Most estate plans strive to transfer wealth and assets to a beneficiary while incurring as little expense (i.e., tax) as possible. A period of declining asset values could enable investors to sidestep some of the bite of estate tax.
The down market advantage: A period of market correction could allow you to transfer more assets under estate law’s various thresholds. For example, let’s say you wanted to transfer 1,600 shares of stock valued at $20/share. The gift tax exemption for 2022 is $16,000, which means you couldn’t transfer all 1,600 shares without exceeding the gift tax threshold. However, if the market correction caused the share price to fall to only $10/share, then you could transfer the entire amount while remaining under the threshold. Other estate planning vehicles, such as intentionally defective grantor trusts and grantor retained annuity trusts, can also benefit from a period of broad asset decline, though their true benefit comes more from a rebound after the decline than the decline itself.
- IRA conversions. Individual retirement accounts essentially come in two flavors: traditional IRAs (where contributions can reduce your tax liability but withdrawals are taxed) and Roth IRAs (where contributions are nondeductible but withdrawals are tax-free). In addition, owners of a traditional IRA can “convert” that account to a Roth IRA – paying tax on the value today but benefiting from tax-free growth going forward.
The down market advantage: While broad market downturns don’t typically boost retirement savings, they create two opportunities with Roth conversions: You can either convert the same shares you would have earlier at less tax cost, or you can convert even more shares than you planned for the same tax cost. Recent legislation removed the possibility of recharacterizing a Roth back to a traditional IRA, so be sure to consult your Baird Financial Advisor to make sure this strategy makes sense for you.
- Investment strategies unique to market corrections. Unlike when a single investment is underperforming or a sector is out of favor, broad market corrections often result from events happening outside the sphere of investing – like a public health crisis, unexpected supply chain breakdowns or the popping of a major market bubble. While often that means there’s nowhere for investors to hide in the moment, it also raises the possibility of a potentially significant bounce once the external event has subsided.
The down market advantage: In the meantime, investors have some options. For example, if you think the downturn is temporary and your portfolio is fundamentally sound, you might see this as an opportunity to “buy the dip” and acquire additional shares at a discount. Or maybe you’ve been holding highly appreciated positions because you don’t want to pay the tax cost to diversify – a down market could be the opening you’ve been waiting for. This could also be an opportunity for tax loss harvesting, a tax strategy where you sell an underperforming position to mitigate this year’s (or a future) tax liability. With this strategy, you might also choose to buy a similar, discounted stock to the one you’re harvesting to take advantage of any potential market rebound. (Know there are IRS wash sale rules around when and what stock you could purchase.) There’s risk in buying or selling in a down market, which makes it prudent to again talk with your Baird Financial Advisor before acting.
One final tip for those near or in retirement: Beware of sequence risk – the possibility that an ill-timed bear market early in retirement, when coupled with annual distributions, will run down your portfolio faster than anticipated. The key to declawing (as much as possible) an early-retirement bear market is to keep saving for retirement. Continuing to work as long as possible or to contribute to a Roth IRA or personal savings account can blunt the effects of a market correction. A “bucket” retirement portfolio strategy that emphasizes short-term, medium-term and long-term income generation could also help you rebound from an early down market.
While these strategies are no substitute for a hard-charging bull market, they can help you make the most of an undesirable situation. For more suggestions on what investors can do in troubling times, reach out to The Gervais Group.
The information reflected on this page are Baird expert opinions today and are subject to change. The information provided here has not taken into consideration the investment goals or needs of any specific investor and investors should not make any investment decisions based solely on this information. Past performance is not a guarantee of future results. All investments have some level of risk, and investors have different time horizons, goals and risk tolerances, so speak to your Baird Financial Advisor before taking action.
Baird Wealth (June 2022)