The Dow Jones Industrial Average dropped more than 1,000 points Monday, rattling investors after several months of relative calm. Some of the year’s biggest winners led the declines in stocks, with Nvidia, Amazon and other technology companies among the day’s losers.
Such a broad decline makes the standard advice from your portfolio manager and financial adviser—do absolutely nothing—awfully unsatisfying. It is also hard to do. There are reasons to be anxious about the economy, including a job market that shows signs of cooling, sluggish consumer spending and rising geopolitical instability.
Still, keep in mind that our portfolios are, ideally, set up to weather ups and downs. Better to stick to a plan than act impulsively.
“If you’re tweaking based on today’s decline, you’re doing it all wrong,” said Noah Damsky, a financial adviser in Los Angeles.
Though doing nothing is often the right move when markets drop, there are some exceptions. Investors can use a market selloff as an opportunity to lower their future tax bills or to invest extra cash parked in savings.
Roth conversion
A steep drop in stock prices can boost the tax advantages of financial moves that you may already have in the works.
One is a lighter tax hit when converting a traditional retirement account into a Roth IRA or Roth 401(k). With a Roth, investors get spared having to pay taxes on future investment gains, but the upfront tax bill can be steep since the converted balance counts as taxable income that year.
When stock prices fall, the tax bill for the conversion often falls too. If one day you had a $50,000 portfolio in a pretax retirement account, turning it into a Roth would require paying taxes on that money now at your regular income-tax rate. But if, a couple of days later, the value of those investments dropped to $45,000, it would now be cheaper to convert it to a Roth.
Investors should be careful about converting an amount of money that would push them into a higher tax bracket, which would make the move more costly, said Kelley Long, a financial planner in Tucson, Ariz.
Tax-loss harvesting
Another tax move: Use the selloff to dump lackluster investments in taxable accounts and harvest those losses.
If you sell stocks you bought for $10,000 for $9,000, that $1,000 loss can offset other capital gains. If you then sold another stock at a $1,000 gain, the two would cancel each other out and you wouldn’t owe any taxes.
These losses can help offset taxable gains in the same year or be banked for later. In fact, the losses can be used at any point during your lifetime.
“When you have these extraordinary circumstances, you don’t want to waste the opportunity,” said Jude Boudreaux, a financial planner in New Orleans.
If you have underperforming investments that you don’t expect will improve much, you should be selling anyway—the tax benefit is a sweetener, said Timothy Wyman, a financial planner and lawyer in Southfield, Mich. “It gives you an excuse to do the right thing and get out of an underperforming area,” he said.
In addition to using losses to offset gains, you may be able to save on taxes by using any extra losses, up to $3,000, to offset ordinary income on your tax return.
Taking cash off the sidelines
The selloff could also let you put some cash to better use.
Retail investors have about $2.5 trillion parked in money-market funds, according to the Investment Company Institute. If there is money they won’t need until years in the future, they would be wise to consider deploying it into longer-term investments in stocks or bonds. Though not necessarily all at once.
One strategy is to invest in smaller amounts at regular intervals, said Francisco Ayala, a financial planner in Phoenix. For example, he suggested investing 10% of the cash a week for 10 weeks rather than in one chunk.
People also leave cash uninvested in retirement accounts. Savers lose out on more than $172 billion a year in retirement wealth as a result, according to estimates from a recent study by Vanguard Group.
“Right now is a great time to make sure you don’t have extra cash laying around in your 401(k),” said Matt Fizell, a financial planner in Madison, Wis. “If you’re five or more years out from retirement, it’s unlikely you’ll need liquidity in this type of account,” he said.
Write to Joe Pinsker at joe.pinsker@wsj.com, Ashlea Ebeling at ashlea.ebeling@wsj.com and Veronica Dagher at Veronica.Dagher@wsj.com
