Jonathan Clements's Blog, page 333

Harder Than It Looks

FOLLOWING the stock market’s steep decline, sensible investors are faced with three alternatives. The first two are fairly straightforward, but the third option is worth some discussion.

1. Do nothing. If all of your assets are in retirement accounts and you’re comfortable with your risk level, you might choose to tune out the news and do nothing at all. Similarly, if your portfolio doesn’t include any stock market investments, you might opt to watch the market upheaval from a distance, without feeling the need to make any changes.

2. Tax-loss harvesting. If you’re comfortable with your overall risk level but have stocks in taxable accounts, I highly recommend tax-loss harvesting. How does this work? The idea is to sell an investment at a loss and then immediately reinvest the proceeds in a similar, though not identical, investment.

For example, if you owned a collection of large-cap stocks—such as Apple or Microsoft—and collectively they’re at a loss, you could sell them all and purchase an S&P 500 index fund with the proceeds. This would allow you to book the loss for tax purposes, while still maintaining the same overall level of stock market exposure.

You could then apply that tax loss—up to $3,000—against your ordinary income. Alternatively, you could use that loss to offset capital gains when you sell another investment at a profit, either this year or in the future. This is a great strategy. Just be careful not to run afoul of the wash-sale rule, which would negate the tax loss.

3. Rebalancing. This is the most aggressive, and potentially most profitable, of the three strategies. The idea is to sell investments that have gained in value—probably bonds at this point—and to redeploy the proceeds into other types of investments that have declined in value, which would likely be stocks.

This is perhaps the hardest action to take in all of personal finance. Why? It means parting ways with an investment that looks stable and profitable, and instead opting into an investment that looks volatile and risky. But it’s also the action that has the greatest potential to benefit your portfolio, because it means selling something at a high price and buying something else at a low price. It’s exactly what we all know we should be doing.

But this is easier said than done. After witnessing the stock market’s wild swings in recent weeks, you may be wondering whether it’s safe to rebalance now or if it would be better to wait. After all, if you wait and the market continues to decline, you’ll have the chance to buy stocks at even cheaper prices. Then again, if you wait and the market ends up rebounding, you may lose out on this opportunity.

Fortunately, there is research on this topic, and it’s instructive. According to a study by Gobind Daryanani titled Opportunistic Rebalancing, there are two key ingredients to optimal rebalancing:

Rebalancing rule No. 1: Rebalancing doesn’t need to follow any specific schedule. For instance, some people favor rebalancing annually. But Daryanani’s research suggests letting the market be your guide. If markets are calm, there may be no need to rebalance for months or years at a time. But when markets go to extremes, that’s when you want to respond. The upshot: While I never recommend obsessively checking account balances, it does help to be generally aware of what the market’s doing, so you know when to check for possible rebalancing opportunities.

Rebalancing rule No. 2: Don’t be too quick to rebalance. As we’ve seen over the past three weeks, markets exhibit momentum. When they’re going up, they tend to keep moving up for a while, and vice versa. For that reason, you don’t want to rebalance every time your portfolio gets just a bit out of line with your asset allocation targets.

Instead, you want to give it some latitude: If the market’s going up, and you’re making money, let things ride for a while. By the same token, when the market is falling, don’t be so quick to presume that it won’t get worse. Instead, give the market an opportunity to decline further before you choose to step in. What you want to do, according to Daryanani, is to wait for an optimal trigger point before making a trade.

What is that optimal point? Daryanani recommends taking action when your portfolio falls out of line with one of its allocation targets by more than 20%. For example, if your target allocation to stocks is 60%, you would set outer bounds equal to 20% of that 60%, or 12 percentage points. Then, if the market were rising, you would wait until your allocation to stocks reached 60 plus 12, or 72% of your total portfolio, before rebalancing.

Similarly, if the market were falling, you would wait until your allocation to stocks dropped to 60 minus 12, or 48% of your overall portfolio. Right now, that number isn’t too far away. The upshot: Hard as it may be to put new money into stocks amid the current turmoil, the research indicates that the odds will be in your favor if you do just that.

Adam M. Grossman’s previous articles include Manic Meets Math,  What Should I Do  and  Don’t Tinker . Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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Fear Not

I DON’T KNOW when the coronavirus will stop spreading, when we’ll have a vaccine and how much the economy will slow. I also don’t know at what level the stock market and interest rates will hit bottom—or whether we’ve already seen the worst. And nobody else does, either. But that doesn’t mean we should all just sit on our (frequently washed) hands.

While we don’t know how bad things will get, we’ve seen this movie before. Do you remember the panic after the Sept. 11 terrorist attacks, with folks buying gas masks, duct tape to seal windows, bottled water and canned goods, and families planning where they’d rendezvous if they couldn’t return to their homes? Do you remember how people hoarded cash in late 2008, because they weren’t sure the banks would reopen, and how many thought we’d see a repeat of the Great Depression of the 1930s?

The coronavirus may be highly contagious. But so, too, is fear.

But should we be so fearful? This time around, we can be reasonably confident that the economic impact will be temporary. Medical researchers are saying we could have a vaccine by next year and they may discover that existing drugs, currently used for other diseases, are effective against the coronavirus. Meanwhile, think about all the cruise ships, airplanes, factories, sports stadiums and office buildings that may sit empty in the months ahead. Guess what? When the coronavirus comes under control and consumer spending revives, all those assets will still be there, ready to be used. The damage to the economy will not be permanent.

What should we do in the meantime? Amid all the uncertainty, here are five steps that could bolster your finances:

1. Don’t wait for good news. If you’re in a mood to buy stocks—which I am—and you want to invest at low prices, you’ll have to buy amid grim headlines. The stock market looks ahead, so this market will bottom long before economic activity revives or a vaccine for the coronavirus is discovered.

And don’t even bother tracking the unemployment rate. That’s a lagging indicator. If we enter a recession, unemployment will rise, and it won’t start coming down until months after both the stock market starts to rebound and economic activity picks up.

Through this decline, buying stocks has felt like tossing dollar bills into a bonfire. But that’s also how it felt 11 years ago, during the 2008-09 stock market collapse. With the exception of the money I invested after Thursday’s 10% plunge, every dollar I’ve invested in stocks this year is underwater. But if stocks keep falling, I’ll keep buying, because I fully expect the market to recover.

How can I be so confident? Ultimately, the stock market is a reflection of the economy. Yes, we will see a pause in economic activity. But soon enough, the world will be back to business. What’s required of investors now is courage, along with diversification, optimism and patience. Embrace those qualities and—in the years ahead—you’ll be handsomely rewarded.

2. Play your final card. It’s the financial advantage none of us is happy about: One day, we will all shuffle off this mortal coil. That could be the key to generating income in today’s virtually no-yield bond world. Yes, I’m once again pitching one of the financial world’s least popular products: immediate-fixed annuities that pay lifetime income.

Over the past three months, the 10-year Treasury note’s yield has dropped from 1.8% to below 1%. But bond yields are only one component in the pricing of immediate annuities. The other key component is life expectancies—and those have barely budged. Result? While the income you’ll earn by buying bonds has been almost halved, the income from an immediate annuity has hardly dropped.

Imagine a couple, both age 70, who stash $100,000 in an immediate annuity that’ll pay income every month until they’re both deceased. Today, that annuity might pay some $460 a month, versus $500 three months ago, according to HumbleDollar contributor Dennis Ho, who runs the website SaturdayInsurance.com. If you need income to supplement whatever you receive from Social Security—and bonds will no longer do the trick—seriously consider an immediate fixed annuity.

Why is the payment on an income annuity so generous? First, each month, the insurance company is effectively returning part of your initial investment to you. Second, the insurer knows that some annuity buyers will die early on, having received little money back from their big annuity investment. These unfortunate folks subsidize the handsome monthly payments that continue flowing to those enjoying a longer life.

Please note that I’m talking here about plain-vanilla immediate fixed annuities. I’m not advocating variable annuities or equity-indexed annuities, which are far less appealing and which insurance salespeople love to peddle, because these products can earn them a hefty sales commission.

3. Prepare for unemployment. The coronavirus will crimp global economic growth, though we don’t yet know how much. Will U.S. employers start making massive layoffs? As a precaution, those in the workforce should ponder how they’d cope with a long period of unemployment.

I tackled this possibility in an article 15 months ago—and my advice today remains the same. What’s the best way to prepare? Your top priority should be making sure you have easy access to cash, and lots of it.

A digression: Many view an inverted yield curve as an almost infallible predictor of recessions. Sure enough, the yield curve inverted in 2019 and it now seems we may get a recession. But this time around, I think we’ll need an asterisk in the record books. An inverted yield curve may predict a recession, but can it really predict a pandemic?

4. Hide that wallet. The surest way to make your portfolio grow—or slow its shrinking—is to save more if you’re still in the workforce and spend less if you’re retired. Indeed, for retirees, varying your spending is one of the most powerful levers at your disposal: You can’t stop the financial markets from falling, but you can limit the other big subtraction, which is the amount you pull from savings each year.

Of course, if we all cut back our spending, it won’t be good for economic growth. But let the policymakers worry about that. You should focus on shoring up your own family’s finances. And, frankly, spending less may prove surprisingly easy in the months ahead. As the coronavirus dissuades all of us from going to restaurants, sporting events and concerts, and from booking trips on airplanes and cruise ships, it should be a breeze to rein in the family budget.

5. Don’t tax yourself. In the category of “things you can control,” don’t forget taxes. In recent weeks, there’s been much talk about harvesting tax losses. The idea is to sell underwater stock positions in your taxable account, so you realize the capital loss for tax purposes, and then immediately reinvest the money in other stock investments, so you maintain your market exposure while sidestepping the wash-sale rule.

But even as you look to save on taxes, also avoid compounding your market losses by realizing big capital gains. Let’s say you have a $100,000 stock fund position that you bought years ago for $40,000. If you sell, you’ll likely have to pay a 15% capital-gains rate on your $60,000 gain, handing you a $9,000 tax bill. Add that to your market losses and you’ll likely find you’re down far more than the broad market averages.

Latest Articles

HERE ARE THE NINE other articles published by HumbleDollar over the past week:

When the financial markets give you lemons, make lemonade: James McGlynn spots four opportunities amid the decline in share prices and bond yields.
Suppose the economy came to a standstill and corporate America made no money in 2020. Even then, says Adam Grossman, that wouldn’t justify much of a drop in share prices.
What’s the best way to generate retirement income? Jiab Wasserman looks at the three main strategies.
Quarantine your emotions every time the Dow drops 1,000 points, plus nine other steps that’ll help you preserve your sanity and your portfolio during this market swoon.
Which is riskier right now, owning stocks or taking a cruise? Richard Quinn is finding out.
Even if you don’t earn a handsome salary, you could still clean up financially—thanks to company stock and a cutting-edge 401(k) plan. Sanjib Saha explains.
What if the stock market falls further? Dennis Friedman discusses four lessons he’s learned from earlier bear markets.
Investment newsletters like to tout their track record and their unique investment process. But the data say you’d be better off in index funds, says Mark Eckman.
Now that U.S. stocks have entered a bear market, are you fearful and perhaps even panicking? Jiab Wasserman offers a three-point plan.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Bad News, Don’t Lose It and Four Questions.

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Grab the Wheel

WHILE JIM AND I cooked dinner the other night, we talked about the old cars we drove when we were younger—and how they tended to pull to one side if we took our hands off the steering wheel. We humans have a similar tendency: We head in one direction unless we make a conscious effort to be more rational.

That brings me to the coronavirus and accompanying stock market plunge. We all have gut reactions to news like this. Many of us drift toward fear and even panic. If you find that happening, try these three steps:

1. Have a roadmap. Instead of reacting to the news, each of us needs a plan that’ll keep us on course. As we go from childhood to adult life to retirement, we all have financial goals along the way, things like funding college, building an emergency fund, paying off debt, amassing wealth, starting a business and more. Once we’ve developed a financial plan to take us from here to where we want to be, we need to stick with it, no matter how great the temptation to stray.

For instance, three of my top priorities were saving for my children’s college, paying off the mortgage and retirement. The 2008-09 Great Recession was perhaps the scariest financial time since the Second World War. But at that juncture, my goals were still many years away, so I stuck with my plan. I continued to fund college and retirement accounts, while also sending in extra mortgage payments as often as I could. I had to cut back on luxuries, including vacations, but I kept my priorities dead center.

2. Know your risk tolerance. We need to be aware of how we react during times of stress and then plan for it. For example, when stressed, do you tend to overeat or skip exercise? To counteract these tendencies, you might find an exercise partner, which makes it harder to avoid workouts, while also stocking up on healthy foods, so—even if you overeat—you are at least eating healthily.

Similarly, we all need a portfolio that we can live with through the ups and downs of the financial markets—especially the downs. If we’re taking the right amount of risk, and we know why we’re investing, it’s a lot easier to stay disciplined.

Jim has a higher risk tolerance than me. When we were saving for retirement, his nest egg was invested entirely in stocks, while I had a more balanced portfolio. Today, now that we’re semi-retired, Jim has shifted to be more conservative, so we both own  a mix of 50% stocks and 50% bonds.

3. Adjust if necessary. While we all have a tendency to react based on gut instinct, we also have the ability to observe ourselves and correct our behavior.

To that end, ponder how you’ve reacted during the current market turmoil. Do you feel panicked and want to sell? If so, ask yourself: Does your plan need to change based on what you’ve learned about your risk tolerance?

If you’re young and still in the workforce, try to see this recent decline as a good time to buy into the stock market. Indeed, given the current buying opportunity, perhaps your roadmap should be modified, so you increase or even max out your contributions to your IRA or 401(k).

If you’re near retirement and now feel you have too much in stocks, perhaps you need to own a more balanced portfolio. When should you change your mix of stocks and bonds? With the S&P 500 off 27% from its all-time high, this isn’t a good time to sell. Still, you might ease out of stocks over the next 18 or 24 months, unless the market comes roaring back, in which case you should probably shift to a more conservative mix right away.

And if you’re already retired, hopefully you have a roadmap that anticipated a market decline. But if you didn’t, this is a good time to see if your plan needs to change. For instance, should you consider immediate fixed annuities, so you can sleep better at night knowing you’ll receive regular income, no matter what happens in the stock market?

In 2017, Jiab Wasserman left her job as a financial analyst at a large bank and is now semi-retired. Her previous articles include In Withdrawal, Time Well Spent and Those Millennials .  Jiab and her husband Jim, who also writes for HumbleDollar, currently live in Granada, Spain. They blog about downshifting, personal finance and other aspects of retirement—as well as about their experience relocating to another country—at  YourThirdLife.com .

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At Sea

I WRITE THIS from somewhere in the Atlantic. We’re headed toward the Falkland Islands, where we’ll apparently see penguins. My wife and I booked this cruise months ago. Since then, of course, we’ve been told repeatedly that being on a ship for 30 days with mostly 60- to 80-somethings is not the best idea. Who knew?

There was a time when getting away meant little connection to the outside world. No more. My iPad and iPhone keep me connected, although it’s my fault that I insist on looking. I’m addicted to information.

This week has been especially trying, as I watch the stock market do its yo-yo act, while coronavirus hysteria runs amok, along with rumors that all cruise ships will be quarantined. Let’s see: Which is riskier, owning stocks or taking a cruise? Oh wait, I’m in both those boats.

One day, I “lose” $100,000. The next day, it’s another $50,000. “Stop looking,” my wife says, after I recount our losses. She’s right, of course, but I can’t help myself.  “How come you never tell me on the days when we make money?” she adds.

My logical mind says, “stay the course,” sometimes even “buy now.” That, by the way, is what my wife also says. Then I remind her that we need a new car now that hers is kaput.

I’m well diversified and, even though I’m age 76, I don’t live off my investments. Roughly 60% of my assets are in bonds, including municipal bond funds. But even my diversification hasn’t stopped the onslaught. My most volatile investment, it turns out, is a single utility stock. It’s the same company that once employed me and now provides me with a pension. Logical or not, I have a measure of loyalty.

I make no claim to be an expert. But I feel I’m fairly knowledgeable. I spent decades overseeing employee benefits, including pension and 401(k) plans. Those of us with experience in employee benefits—as well as folks in the investment business—can share our sage advice all we want. But for the average investor, this is scary stuff. We’re being constantly pummeled with information, including headlines designed to grab our attention.

People sometimes think at an emotional level and sometimes they think logically. Right now, it’s all emotion, all the time. We’re worrying about the coronavirus, the stock market and the economy. That’s a lot for people to take in, both everyday investors and professionals.

This is likely shaping up to be a great stock market buying opportunity. But simply pointing that out isn’t enough. Instead, to get people to stand their ground and maybe even buy more, we need to help them with their emotional state—and we clearly haven’t figured that one out. After all, if we had, would we be having days when the S&P 500 plunges 8%? There’s panic in the air, when what’s really needed is courage. I can’t tell you where to find it. But if you’re to survive this bear market, you better start looking.

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include Know Your Demons, Brain Meets Money and Count the Noncash. Follow Dick on Twitter @QuinnsComments.

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Letter Grades

WHEN YOU SEE an advertisement, you expect some hype. Ads for investment newsletters are, alas, no exception.

Sometimes, you hear about their unique investment process or how the newsletter regularly beats the market. Some offer one-sentence testimonials from happy subscribers. The message: You, too, can enjoy the benefits of their secret methodologies for a low, low price.

Yes, the ads are undoubtedly compelling. But you need to separate the hype from reality. Fortunately, Hulbert Financial Digest does just that—by tracking the performance of investment newsletters. In a few easy-to-read lists, you can see newsletter results for both the current year and multi-year periods, as well as how the newsletters compare to one another.

But I find it more interesting to see how the newsletters fare against the market averages. Hulbert provides the newsletter data along with seven benchmark indexes. I like to compare the newsletters to the S&P 500’s total return. The latter reflects not only share price changes, but also reinvested dividends.

For instance, the 10-year return for the S&P 500 through year-end 2019 was 13.53% a year. The best-performing newsletter gained 31.05% annually and the worst lost 2.46% a year—quite a range. Some of the newsletters outperformed the index. But the relative performance is telling. The S&P 500 would have ranked as the 15th newsletter on the 10-year list, outperforming 81% of newsletters. Looking at the five-year results, the index would have ranked eighth, besting 91% of newsletters.

Indeed, the index ranks near the top over one, three, five and 10 years, while the newsletters appear inconsistently. Subtracting the cost of a subscription from the newsletter results would make the case for indexing even more compelling.

Hulbert also shows risk-adjusted performance, as measured by the Sharpe ratio. The S&P 500 has a higher Sharpe ratio than the top-performing newsletter, meaning the S&P 500’s risk-return ratio was better. But to be fair, other newsletters had risk-adjusted returns that were superior to the S&P 500. Still, the Hulbert data suggest indexing will typically be a better strategy than following some newsletter guru.

But what if there’s a newsletter with a strategy that you really like? Will you earn the same return as the newsletter? Maybe. It depends on how diligently you follow the recommendations. Some investors trade immediately when their favorite newsletter makes a trade. But many subscribers don’t and, as a result, their returns will differ.

Even if you act on each trade recommendation, there will be a delay between when your newsletter decides to trade and when you receive the information. While the financial markets may react instantaneously to news, newsletter subscribers don’t, though Hulbert’s methodology tries to account for this.

Mark Eckman is a data-oriented CPA with a focus on employee benefit plans. His previous articles were Missing the Target, Alphabet Soup and Financial Pilates. As Mark approaches retirement, he’s realizing that saving and investing were just the start—and maybe the easy part. His priorities: family, food and fun. Follow Mark on Twitter @Mark236CPA.

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Grin and Bear It

IS THE STOCK MARKET swoon messing with your head? You don’t want to make this market decline any worse than it has to be. To that end, here are 10 steps that’ll help preserve your sanity and your portfolio:

Avoid touching both your face and leveraged exchange-traded index funds.
Change the password on your investment accounts to “ItsTooLateToSell.”
Downgrade your opinion of investors based on their degree of hysteria.
Don’t watch Contagion , Margin Call or the New York Knicks.
Quarantine your emotions every time the Dow drops 1,000 points.
After your brother-in-law finishes pontificating, ask whether he inherited his clairvoyance from his mother or his father.
Avoid contact with insurance agents pitching equity-indexed annuities. Don’t shake hands with brokers on any deal that promises downside protection.
Unless you live in a ranch-style house, stay away from open windows.
Wash your hands for 20 seconds after watching CNBC.
Use the vacation fund to buy stocks. Mention it to your spouse after he’s had a few drinks.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Bad News, Don’t Lose It and Stand Your Ground.

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In Withdrawal

RETIREMENT ISN’T just about reaching some magic savings number. You also need a strategy for turning that pile of savings into a reliable stream of retirement income that’ll last for the rest of your life.

In academic lingo, it’s about changing from accumulation to decumulation—and it’s a topic that my husband Jim and I grapple with, as we figure out how best to cover our retirement expenses. There are three common strategies:

Systematic withdrawals. This is the best-known strategy. The goal is to generate a steady, inflation-adjusted flow of income from a volatile investment portfolio. It’s where the famous 4% withdrawal rate comes from.

The notion is that, over a 30-year retirement, the most you can safely spend each year from a balanced portfolio of stocks and bonds is roughly 4% of your nest egg’s starting value. That 4% is the sum withdrawn in the first year of retirement, with the dollar amount withdrawn in subsequent years increasing with inflation. If you use the 4% rule, U.S. market history suggests you shouldn’t run out of money, even if we get high inflation and terrible market returns.

Time-based buckets. This approach sets up separate pools of investments for different time periods in retirement. You might invest conservatively with high-quality bonds and cash investments in the near-term time bucket, take on moderate risk by investing in bonds and some stocks for the next bucket, and perhaps be even more aggressive by investing exclusively in stocks with the long-term bucket.

For example, upon retirement at age 65, a couple might divide their retirement portfolio into three buckets, one for ages 65 to 74, one for 75 to 84, and the third for 85 and beyond.

Income floor. With this strategy, expenses are classified as essential or discretionary. Income from bonds, cash investments, Social Security, pensions and income annuities are used to create a flow of reliable income to cover all essential expenses. Meanwhile, discretionary expenses are funded by a mix of stocks and other riskier investments.

Which approach is best? All three strategies have benefits and drawbacks.

Because systematic withdrawals involve drawing on a mix of stocks and bonds, it gives retirees the opportunity to increase their wealth if markets perform well, but it also carries sequence-of-return risk—the risk of poor market returns early in retirement, which can cause retirees to deplete their portfolio quickly.

The bucket approach appeals to our fondness for so-called mental accounting. Retirees may find they’re comfortable investing the long-term bucket aggressively, because they know they have the other two buckets to cover nearer-term expenses. The biggest drawback: It’s a complicated strategy to execute. When do you refill the near-term buckets? If retirees let the short-term bucket get too depleted, the overall portfolio’s allocation to stocks will increase, creating a riskier portfolio as retirees get older.

Meanwhile, the income floor appeals to retirees who want greater security. The downside: To buy that security, you’ll likely need a large investment in bonds and income annuities—and that means giving up the opportunity to increase wealth if markets perform well.

I personally like the income floor strategy. I would sleep better at night knowing that, no matter what happens in the financial markets, Jim and I will still have a roof over our heads and food on the table. But because we retired in our 50s, it’s expensive to buy annuities. We’re relatively young, plus interest rates are low. So, for now, our decumulation strategy is based on time-based buckets.

But our eventual goal is to create an income floor. At age 70, we’ll both claim Social Security, which will help cover much of our essential expenses. If we need more regular money every month to cover those expenses, we’ll then look to buy income annuities.

In 2017, Jiab Wasserman left her job as a financial analyst at a large bank and is now semi-retired. Her previous articles include Time Well Spent, Those Millennials and Cutting Corners .  Jiab and her husband Jim, who also writes for HumbleDollar, currently live in Granada, Spain. They blog about downshifting, personal finance and other aspects of retirement—as well as about their experience relocating to another country—at  YourThirdLife.com .

Do you enjoy HumbleDollar? Please support our work with a donation.

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Working the Plans

I’VE DEVELOPED a series of what I call “Geico talks,” named after the ubiquitous insurance company commercials. They’re 15-minute talks that, I joke, are aimed at boosting financial knowledge by 15% or more.

The talks are for friends and acquaintances who work at the same company as me or at companies with similar employee benefits. These firms typically have great retirement plans and many employees own company stock. I figured the topics I’d researched for my own finances would help these folks. I also suspected that some friends were making the same mistakes I’d made. With that in mind, I came up with three Geico talks:

1. After-tax 401(k) contributions. Only a minority of 401(k) plans allow so-called mega-backdoor Roth conversions, but it’s worth checking to see whether your plan does. What’s involved? It starts with making after-tax contributions to your employer’s 401(k). These contributions are over and above the usual tax-deductible or Roth 401(k) contribution limit, which in 2020 is $19,500 for those under age 50.

The after-tax contributions can sometimes be immediately converted to the company’s Roth 401(k), where the money grows tax-free thereafter. Alternatively, the after-tax dollars can be transferred to a Roth IRA, either while you’re still employed or when you leave the company. If the money ends up in a Roth IRA, either immediately or when you leave your employer, it also escapes the rules for required minimum distributions that apply starting at age 72.

My employer’s 401(k) plan allows both after-tax contributions and the ability to convert that money over to the Roth 401(k) option. Ditto for the employers of some friends. Be warned: If you convert to a Roth and the after-tax dollars have enjoyed some investment gains, the conversion will trigger a tax bill, though it’ll typically be modest.

2. Company stock. Many employers—especially technology companies—offer stock-based compensation. This bolsters employees’ commitment and allows them to participate in the company’s growth. Over time, workers can build up sizable holdings of company stock. If the stock does well, as has been the case for some tech companies, it often becomes a significant portion of the individual’s total stock market holdings. The percentage looks even higher if unvested shares are added to the mix.

My employer makes stock grants as part of an employee’s compensation package, offers a discounted employee stock purchase plan and makes its publicly traded shares available within the 401(k). Most employees accumulate a sizable number of shares each year. We’ve been lucky: The stock has outperformed the broad U.S. stock market by a large margin over the past decade. Result? Several old-timers have ended up with more than half of their stock portfolio in our employer’s shares.

Our employer is viewed as a stable, large-cap company with a proven track record and a promising future. Still, overexposure to a single stock poses significant risk—so-called unsystematic risk. Unfortunately, optimism and recency bias can blind employees to the magnitude of this risk.

Even those aware of the financial danger involved are often hesitant to do anything about it. The potential tax bill discourages them from selling. Still, we shouldn’t let taxes drive such a crucial investment decision. Selling pricier lots, harvesting tax losses, gifting shares and other strategies can ease a lot of the tax pain.

3. Net unrealized appreciation. Tax-deductible contributions to a 401(k) grow tax-deferred. But when the money is withdrawn, the entire sum is taxed at the ordinary income rate, even when the growth is due to long-term capital gains. Such capital gains are usually taxed at a lower rate, but only if they occur in a regular taxable account.

Wouldn’t it be nice to get the best of both worlds, enjoying both tax deferral and the lower capital gains tax rate? The net unrealized appreciation, or NUA, strategy can achieve just that—if you hold company stock in a 401(k).

How does this work? An employee buys company shares in the 401(k). The plan keeps track of the stock’s cost basis—the amount the employee paid for the shares. If the shares appreciate substantially by the time the employee retires or leaves, the employee will likely want to request that the shares be distributed to a taxable account, while the rest of the 401(k) gets rolled over to an IRA.

The employee immediately owes ordinary income tax on the company stock, but only on the cost basis. Meanwhile, the unrealized gain on the stock would be taxed at the lower capital gains tax rate when the shares are sold. If the shares appreciate further and are sold after a year, that extra gain also gets taxed at the favorable long-term capital gains rate.

The NUA is often advantageous, but it isn’t always the best choice. In particular, the immediate income tax bill can be steep if the cost basis on the shares is high—in which case you might want to skip the NUA strategy and instead defer the tax bill by rolling everything into an IRA.

A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Got Gold, Risky Option and Thanks for Nothing. Self-taught in investments, Sanjib passed the Series 65 licensing exam as a non-industry candidate. He’s passionate about raising financial literacy and enjoys helping others with their finances.

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Bearing Up

STOCKS HAVE YET to close 20% below their Feb. 19 all-time high, so technically the U.S. market hasn’t entered bear market territory. Still, after this morning’s sharp drop, the S&P 500 is 17% below its peak.

If this decline does indeed become a bear market, how can you prepare yourself? A bear market can be an emotionally gut-wrenching time—one that leaves you feeling vulnerable and helpless. But there are steps you can take to limit the damage to your investment portfolio. In particular, here are four lessons I’ve learned from previous bear markets:

1. Favor high-quality bonds. All bonds do not perform the same in a bear market. In fact, some bond funds can be as volatile as stocks. During the 2007-09 bear market, I owned two bond funds: Vanguard Total Bond Market Index Fund and Vanguard High-Yield Corporate Fund. According to Vanguard Group’s site, the high-yield fund invests in “medium- and lower-quality corporate bonds, often referred to as ‘junk bonds’.”

In 2008, the total bond fund gained 5.15%, while the high-yield fund tumbled 21.29%. During bad economic times, people prefer better quality bonds, because there’s a higher likelihood that they’ll get paid. The total bond fund invests a significant portion of its assets in U.S. government debt, probably the safest investment to own during depressed economic times. Meanwhile, junk bonds are lower quality and hence at greater risk of defaulting on their interest payments.

Result: Short- and intermediate-term government bonds are good choices in a bear market. Although they may not provide as much income as other bonds, they offer the stability your portfolio needs in turbulent times.

2. Avoid individual stocks and sector funds. Why? You want to be confident all your holdings are viable long-term investments, so they’ll bounce back when the market recovers.

Even mutual funds can go out of business in tough times. Merrill Lynch launched its Internet Strategies Fund in March 2000, just as the tech bubble was bursting. The fund lost a shocking 70% and went out of business in just over a year. According to U.S. News & World Report, “While Internet Strategies had what was perhaps the industry’s most embarrassing timing, it was hardly the only fund to close its doors in the wake of the bubble.”

Result: For your portfolio’s core holdings, stick with broad-based index funds. When you invest in a U.S. total stock market index fund, you’re investing in the total U.S. economy. Not all U.S. companies will survive an economic downturn, but we know the U.S. economy will.

3. Cash is king in a bear market. You never want to lock in your investment losses by selling stocks at a market bottom. You need to have enough cash to ride out the downturn and give your stock market investments a chance to recover.

According to CBS News, “On average, bear markets have lasted 14 months in the period since World War II, while market corrections have lasted an average of five months. The S&P 500 index has fallen an average of 33% during bear markets in that time. The biggest decline since 1945 occurred in the 2007-2009 bear market,” when the S&P 500 fell 57%.

Result: If you’re living off your investment portfolio, you should have a cash reserve equal to at least two to three years of living expenses, so you can withstand the onslaught of a bear market and avoid the need to sell stocks. On top of that, you’ll likely want a substantial allocation to bonds.

4. Stay the course. You need to have the courage to stick with your investments in difficult times. Making radical changes to your portfolio during a bear market is usually a losing proposition.

Result: Having the right mix of stocks and more conservative investments should give you the fortitude to stay the course during a bear market. Not sure you have the necessary courage? Consider hiring a fee-only financial advisor to help coach you through the decline.

Dennis Friedman retired from Boeing Satellite Systems after a 30-year career in manufacturing. Born in Ohio, Dennis is a California transplant with a bachelor’s degree in history and an MBA. A self-described “humble investor,” he likes reading historical novels and about personal finance. His previous articles include Time to Shrug, Small Is Beautiful and On My Mind. Follow Dennis on Twitter @DMFrie.

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Four Opportunities

I FIRST STARTED managing mutual funds a few months before the 1987 stock market crash, and I’ve had to navigate a fair number of market declines since then. My advice: Instead of worrying about how far share prices will fall or how widely the coronavirus will spread, think about the opportunities. I spy four of them.

1. Buy the dip. If you have cash, you might slowly dollar-cost average into the market, so you take advantage of today’s lower share prices. Alternatively, you could rebalance your portfolio from bonds to stocks and take advantage that way.

I don’t think you need to rush to buy—but I also don’t think you should be scared to do so. Unlike 2008-09, it doesn’t appear that the financial system is on the verge of a meltdown. Back then, the housing market helped drag down the economy. This time around, real estate might help prop up the economy, as falling interest rates bring down mortgage rates and make housing more affordable.

2. Refinance. Mortgage rates are usually pegged to the interest rate on 10-year Treasury notes, which ended Friday below 0.8%. That brings me to the second opportunity: With this sudden drop in interest rates, I’ve started the process of refinancing my mortgage. Interest rates have fallen enough that I can swap from a 30-year mortgage to a 15-year mortgage without substantially increasing my monthly payment.

There’s also an opportunity here for retirees. Instead of doing a complicated reverse mortgage, retirees who need cash from their homes might refinance and take out money that way. Why should the U.S. Treasury be the only one to lock in today’s low interest rates?

3. Take tax losses. Before this market correction, your regular, taxable investment account might have only contained gains. But let’s say you own some energy stocks. The sector was weak last year and has gotten weaker with this downdraft, so you might be able to do some tax-loss harvesting.

That might mean selling one energy stock, so you realize a capital loss, and then replacing it with a similar company or with an exchange-traded index fund that’s focused on the energy sector. That way, you maintain your exposure to the energy sector while getting your tax break. Why not buy back the same stock? That could negate the tax loss if you violate the wash-sale rule, which happens if you repurchase the same stock within 30 days of selling it.

4. Roth conversions. You can benefit from lower stock prices by converting part of your traditional IRA to a Roth IRA. For the last five years, I have been doing partial Roth conversions each year. Because of the market decline, I’m planning to convert some stocks that are down this year.

What’s the benefit of doing a Roth conversion during a market downturn? Thanks to lower share prices, I can transfer the same amount of stock from my traditional IRA to a Roth and generate a smaller income-tax bill, because the shares are worth less. Let’s say you have an international stock fund or an energy company whose value is depressed. You can choose how much and which specific holding to transfer to your Roth. There will probably be no cost to do the transaction, especially with the recent slashing of commissions.

Even though the downturn makes a Roth conversion more appealing, keep in mind that the money transferred will count as ordinary income on your 2020 tax return, though the tax bill be somewhat reduced if you’ve made nondeductible contributions in the past. Be sure to make estimated tax payments to cover that tax bill.

James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. His previous articles include Gives That Gift Back, Danger: Cliff Ahead and Early and Often.

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