July 18, 2024

What stock market experts say about investing amid high inflation. Traders work the floor of the New York Stock Exchange.
Inflation and interest rates are soaring. Stocks are plummeting and bond funds could post their worst year ever. What’s an investor to do?
The standard advice is to not make any drastic changes to your long-term strategy in response to short-term gyrations. Investors who panic sell during a downturn often miss out on market recoveries; others “buy the dip” too soon.
However, “that doesn’t mean never do anything,” said Roger Young, thought leadership director at T. Rowe Price.
Here are some things investors can do now in response to changing conditions that don’t constitute market timing. Be sure to read up on the details or better yet, consult a legal, tax or financial adviser.
Boost your yield: If you still have money sitting in a checking or savings account yielding next to nothing, put that cash to work. Thanks to the Fed’s five rate hikes this year, it’s possible to earn 2% to 4% with little effort or risk.
Many online banks are offering 2% or more in high-yield savings and money market accounts insured by the Federal Deposit Insurance Corp. Find such offers at Bankrate.com .
You can also earn upwards of 2% on money market mutual funds managed by firms such as Vanguard, Charles Schwab and Fidelity . These are not FDIC insured but are considered low risk; some invest only in U.S. government securities.
If you can tie up your money for a bit, consider buying shorter-term U.S. Treasury securities. On Thursday, annual yields ranged from 2.8% on a one-month bill to roughly 4% and 4.2% on one- and two-year maturities, respectively.
You can buy them from the government by opening an online Treasury Direct account at Treasurydirect.gov and linking it to a bank account. Treasurys are backed by Uncle Sam and their interest is exempt from state and local (but not federal) income tax.
“The one- or two-year Treasury has one of the best risk-reward profiles you will see in the marketplace now,” said Chris Wheaton, senior investment adviser with Litman Gregory Wealth Management in Larkspur.
You can’t buy Treasurys for an IRA through Treasury Direct, but many brokerage firms will let you buy them in an IRA or taxable account. Check to see if there is a commission.
Some brokerage firms are also offering certificates of deposit from FDIC-insured banks (called brokered CDs) with yields rivaling Treasurys. In some cases, yields on brokered CDs are much higher than what the same banks are offering their own customers.
I bonds: Another option is the Treasury’s inflation-linked I bonds. Their interest rate is linked to the consumer price index and changes every six months. On the first business day of May and November each year, the Treasury announces the rate that will apply to I bonds purchased within the next six months.
Bonds purchased before Nov. 1 will earn an annual rate of 9.62% for the next six months. Every six months after your purchase, the rate on your bond will adjust to the then-current rate.
You can purchase I bonds in a Treasury Direct account or in paper form with a federal tax refund. Purchases are limited to $10,000 per person per year (in electronic form) and $5,000 (paper form). Interest is exempt from state and local (but not federal) income tax.
You must hold I bonds for at least one year. If you cash them in before five years you lose three months of interest. You cannot buy them in an IRA.
Tax-loss harvesting: If you have losses on investments in a taxable account, consider selling some to generate a capital loss. Come tax time, you can deduct these “realized” losses from capital gains you realized when you sold investments at a profit or received capital gains distributions from mutual funds.
If your capital losses exceed your capital gains this year, you can deduct up to $3,000 in remaining losses from your ordinary income, such as income from a job or pension. If you still have losses remaining, you can carry them into future years to offset first capital gains and then up to $3,000 in ordinary income, until your losses are exhausted.
This strategy can be especially useful in California, which taxes capital gains the same as ordinary income at rates up to 13.3%.
Caveat: If you sell something at a loss and repurchase the same or a “substantially identical” security within 30 days before or after the sale, you will violate the “wash sale” rule and won’t be able to write off the loss on that year’s tax return.
If you want to generate a loss but don’t want to be out of the market, you could immediately buy a similar, but not substantially identical, investment. For example, you could sell a Standard & Poor’s 500 index fund and buy a total U.S. stock market fund or a Russell 1000 fund and get similar returns. Or you could sell a stock and buy a fund that invests in the same industry.
Most people do this in December, when they have a better picture of their tax situation for the year and have received information about capital gains distributions, but you don’t have to wait until then.
Note: This strategy won’t create a tax benefit in IRAs and 401(k) accounts.
Roth conversions: If you think assets held in a traditional IRA are poised for a rebound, “without changing your overall allocation, you could convert some of your traditional IRA to a Roth,” Young said.
The amount converted will be taxed as ordinary income but from that point forward, you generally won’t pay taxes on the Roth IRA. (Account earnings could be taxable if you withdraw them before meeting certain holding requirements .) By comparison, if you keep the money in a traditional IRA, every dollar you take out will be taxed as ordinary income.
You can also convert money from a traditional pre-tax 401(k) account to a Roth 401(k), if your employer allows.
There is no income limit to do a Roth conversion; nor is there a limit on the amount you can convert at any time.
Another benefit: When you turn 72, you won’t have to take required minimum distributions from your Roth IRA each year, like you do with a traditional IRA or 401(k). However, those with Roth 401(k) accounts generally do have required distributions once they reach 72, if they haven’t yet rolled those dollars over to a Roth IRA, said Jeffrey Levine, chief planning officer with Buckingham Wealth Partners.
Also, heirs (other than a spouse in some cases ) must take required distributions from inherited Roth accounts, as they would from traditional IRAs and 401(k) plans.
Warnings: The additional income from a conversion could push you into a higher tax bracket, trigger a temporary surcharge on Medicare Parts B and D premiums or impact the taxation of Social Security benefits. And once you convert assets to a Roth account, you can no longer undo or “recharacterize” the conversion.
“Market dips are a good opportunity for Roth conversion,” Wheaton said. “The assets are worth less and if you think there will be a rebound over the next few years it makes sense to convert some.”
Stock compensation: If you exercised stock options or vested in restricted stock units early this year when stock prices were higher, “consider whether you should re-evaluate your strategy,” said Helen Dietz, West Coast managing director with Aspiriant, a wealth management firm.
When restricted stock units vest, the value on the vesting date is added to your ordinary income for the year. The company will withhold a certain amount to cover taxes, but it might not be enough to cover the full amount due. If the stock price has gone down, you might want to sell some shares to raise cash and realize a capital loss. (See tax-loss harvesting above.)
Likewise, if you exercised nonqualified or incentive stock options at the beginning of the year and haven’t sold the underlying stock, “consider if it still makes sense to keep holding that,” Dietz said. There could be regular and alternative minimum tax issues. “There were many articles written about how tech people exercised stock options in 2000 and got stuck with a tax liability they weren’t prepared for.”
Gift and estate planning: Wealthy families whose estates could be subject to estate tax may want to give some undervalued assets to their eventual heirs today, when the federal lifetime gift and estate tax exemption is at a record high, $12.06 million per person. This exemption will drop after 2025 to $5 million plus an inflation factor, which would bring it to about $7 million in 2026, unless Congress changes the law.
“If you have an asset whose value is temporarily low because of market conditions, maybe a business or building impacted by Covid, it’s a good time to consider gifting that asset. It will use less of your federal gift and estate tax exemption,” said Chelsea Suttmann, an estate planning attorney with Barulich Dugoni & Suttmann Law Group in San Mateo.
Also, any person can give, to any number of individuals, up to $16,000 each this year without having it come out of their lifetime gift and estate tax exclusion. If you have stock, for example, that was worth $20,000 but is now worth $16,000, you could get it out of your estate this year without any gift tax consequences.
Intra-family loans: The average rate on a 30-year fixed-rate conforming mortgage has more than doubled this year to 6.7% this year. If your kids can’t afford a home at that rate and you have funds available, consider making them an intra-family loan.
“If I want to loan my kids $1 million and want them to pay me back with no gift involved, I would have to charge them interest at a rate equal to or greater than the applicable federal rate,” Sutttman said. The Internal Revenue Service sets this rate every month. For October, it will be 3.43% for loans longer than nine years. That is up from 1.82% in January but well below commercial rates.
Kathleen Pender is a former San Francisco Chronicle columnist. Email: ka**********@gm***.com
Kathleen Pender was a San Francisco Chronicle journalist for 36 years. After serving as a business reporter and editor, she wrote the Net Worth column from 2000 to 2021, where she explained how the big business and economic news of the day affected a household’s net worth. She majored in business journalism at the University of Missouri-Columbia and was a Knight-Bagehot fellow in business journalism at Columbia University.


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