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Financial Opportunities in a Economic Downturn

October 14, 2023 by

Opportunities in a Downturn

We obviously can’t predict a market down-turn in advance, but we can certainly prepare for one. With the markets in a bit of a doldrums the past month, that preparation may come in handy in the fairly near future.

Whenever stocks go down, it opens up a surprising number of (usually temporary) planning opportunities for the alert investor. Perhaps the most obvious is harvesting losses; that is, selling positions that have gone down, booking a loss for tax purposes, and then buying a similar (but not identical) investment that is probably also on sale due to the bearish conditions. The investor retains an essentially equivalent market exposure, but now has a loss to offset gains or income (up to $3,000 of income) on next year’s tax return.

Heads I Was Good Tails, My Luck Was Bad

Another opportunity is a Roth conversion. That means paying taxes on the value of the shares or cash moving from the IRA into a Roth to-day, so that you won’t have to ever pay taxes on that money again. You’ve probably read that if you expect to be in the same or lower tax bracket in the future than you are today, then a Roth doesn’t make tax sense. But if you can make the conversion at lower valuations, then the tax bill is lower today than it would be if the money was taken out after the mar-ket recovers. And some of us believe that tax rates have no-where to go but up.

People who are making annual gifts to their children or heirs can get a little leverage in a market downturn. Each of us can transfer $17,000 this year to others without paying a gift tax. If you were to transfer investments that are temporarily undervalued, then that $17,000 in depressed ETFs could be a more valuable gift when the market recovers.

And finally, when something goes on sale, it’s often a buying opportunity. For some reason, this is how people think when retail or online stores offer discounted prices, but when stocks go on sale, most investors think sell rather than buy. But buying at de-pressed prices is always a good strategy, long-term, for savvy investors.

The Looming Revert

Mutual fund managers are paid to de-liver value through their research and good judgment about the markets—never mind the fact that study after study has shown that most active managers tend to under-perform over time. A new research report published in September found that fund managers, in their shareholder communications, were more likely to attribute any performance above their benchmark to skill, and any performance that lagged their benchmark, according to them, was the result of external factors beyond their control (bad luck).

The study had an artificial intelligence pro-gram read through 15,434 shareholder reports associated with 1,969 unique funds. The AI reported on the times when the fund manager attributed success or failure to ‘internal factors’ (that is, decisions made by the fund manager and team) or ‘external factors’ (like market downturns or an adverse economic environment)

The result: taken altogether, the research-ers found that the fund managers were 59% likely to attribute good performance to internal factors, and 83% of the time they blamed under-performance on external factors. In other words, when their performance was good, they tended to attribute it to skill, but when their performance lagged the benchmark, they were overwhelmingly blaming it on their lousy luck.

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