Opportunities in a Economic Downturn | October 2023

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 depressed 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.

2023 Third Quarter Investment Report

Nobody is talking about the fact that the tax pro-visions in the Tax Cuts & Jobs Act of 2017 are due to revert back, after December 31, 2025, to what they had been in 2017—just 26 months from now. But if and when that threshold is crossed, it could be a rude awakening for a number of taxpayers.

For example? One of the most dramatic shifts would be the estate tax rates. The federal estate tax exemption in 2017 was $5.49 million; that is, the first $5.49 mil-lion that a taxpayer passed on to heirs would pass es-tate-tax free. Today, that exemption is a whopping $12.92 million; for married couples, the combined ex-emption is $25.84 million. The ‘revert’ would bring ex-emption down to something like $6.5 million—a third as high as currently.

The Tax Cuts & Jobs Act also doubled the standard deduction, which led to few-er people going through the hassle of itemizing deductions. The standard deductions for the 2017 tax year were $6,350 for single filers; $12,700 for people married filing jointly. Today, the standard deduction is $13,850 for single filers; $27,700 for those filing jointly.

The tax table revert would generally put people in higher brackets; most Americans would pay 1-4 percent more in personal taxes under the old reverted-to tax tables than they are currently.

Yes, we still have two years (and two months) to prepare for this. But anyone whose net worth is above the old estate tax threshold should start making plans now for how to get money out of the estate, and everybody should brace themselves for once again having to go through the chore of itemizing deductions—unless Congress comes up with a new tax bill. At that point, anything is possible.

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