Between pandemic lockdowns, health issues, controversial politics, and significant inflation with rising prices, many US investors may feel like they are losing control of their situations. Add to that a bear market for stocks, with a possible recession looming.
To maintain resilience, we can focus on taking care of our physical, mental, and financial well-being and that of our families. We can act now to prepare for tough times in the short term and protect financial options in the long term. We can find a manageable balance between enjoying our money now and saving for what we need later.
There is some good news. Despite the US stock market crash, bear markets are temporary. While each bear market is unique, they tend to last 11-12 months on average and then bounce. Since 1957, the S&P 500
has won an average of 2.9% after one month, 5.5% after six months, and 23.9% after one year after the start of a bear market. Bear markets provide opportunities for sale purchases and tax management.
If a recession hits the US, it will also be temporary. Since 1945, the National Bureau of Economic Research has documented 13 recessions and lasted 10.3 months on average. The last significant recession from 2007 to 2009 lasted 18 months.
While economists are in a “wait and see” mode regarding a recession, now is the time to act and prepare for potential shocks. Here are five ways to manage:
1. Know where you stand financially, starting with cash flow: Are you earning enough money each month to cover your expenses? Income minus expenses equals cash flow. When your income exceeds your expenses, you have positive cash flow. You need positive cash flow to pay down debt or build savings. Is your cash flow positive or negative? You can improve your cash flow by increasing income, decreasing expenses, or a combination of both.
“ Take temporary steps to shore up your finances by paying off credit balances or increasing your emergency fund. ”
2. Increase your income: If you’re financially stressed, improve your cash flow by taking extra shifts, getting a second job, or building your side business. Since a recession is possible, diversifying your income streams provides backup if you lose your main income. You don’t have to do this forever. Take temporary steps to shore up your finances by paying off credit balances or increasing your emergency fund.
3. Cut your expenses with an open mind and a critical eye: If you have negative cash flow and are worried about your finances, take a hard look at cutting costs. With inflation, you may be tapping into savings to cover rising costs. This is not sustainable.
Look at all aspects of your life, starting with housing. How could you lower your monthly housing costs? Think of temporary or permanent possibilities. Could you rent part of your house to subsidize your mortgage and utilities? Sell your house and excess belongings for a smaller place or a lower cost location? Work remotely in a less expensive country?
Next, look at transportation and food. Can you sell your vehicle or trade in your newer car for a less expensive model without paying the car payment? Carpool more? Weekly food prep to avoid ordering takeout? While some of these are not easy decisions, especially if you have children, taking proactive and creative steps can provide additional savings and peace of mind.
4. Find a balance between enjoying your money now and saving for future needs: Life is more than working hard now to enjoy it later. Living for today and saving for tomorrow is a balance with trade-offs. Visit that coffee shop if it helps you during the day and if you have the income to cover the expenses. Do you want to take a family trip? Great, go and enjoy if you have the means. Or enjoy low-cost local activities with family and friends, and apply your stay savings toward a future goal, like funding your retirement account. Creating memories doesn’t require fancy vacations or fancy restaurants.
5. Use the bear market to improve your tax situation: A bear market is an ideal time to convert a taxable traditional IRA to a Roth IRA. Let’s say you contributed $6,000 to your traditional IRA in 2020. You bought 60 shares of an ETF or mutual fund for $100 per share. In this bear market, the shares now cost $75 each and your total investment is worth $4,500. Although it is difficult to digest, this is an opportunity.
When you convert a traditional IRA to a Roth IRA, you pay taxes on the current value to turn your portfolio into a tax-free asset. Roth withdrawals are tax-free, unlike a traditional IRA. By converting now, you pay less tax on the new value of $4,500 instead of the original cost.
Plus, you can cut your tax bill by selling undervalued stock to record a loss. Let’s say you recently sold a rental property that appreciated substantially. You expect a high tax bill on this sale. Knowing this, you can sell shares at a loss to offset the taxable gain on the property.
Or suppose you invested $30,000 to buy 500 shares of a small-cap ETF at $60 per share. The shares now cost $45 each, for a total value of $22,500. He sells them for a loss of $7,500, an item on his 2022 tax return. He can then reinvest the $22,500 in a similar small-cap ETF (its price also weakened) to stay in the market while receiving the tax benefit.
The economy and the market, through their cycles, take us on wild and unpredictable rides. This time, the end is not in sight, but this too shall pass. By taking proactive and creative steps to manage this cycle, you’ll be better prepared to meet your current needs and protect your long-term financial health.
Michael J. Garry is a Certified Financial Planner who runs Yardley Wealth Management, LLC in Yardley, Pennsylvania. He is the author of two books, “The Smart People’s Guide to Financial Planning and Investing: A Simple, Straightforward Approach to Understanding Your Personal Finances.” ” and “Independent Financial Planning: Your Ultimate Guide to Finding and Choosing the Right Financial Planner.”