William Lako: Volatility Can Provide a Planning Opportunity

When trying to gauge market volatility, we first look at what indicators are causing the swings and try to determine whether any of the fundamentals have changed. Currently, unemployment is near its pre-pandemic level at 3.7%; however, the Consumer Price Index is still above 7%, and the University of Michigan’s Consumer Sentiment is at a level lower than we saw in the Great Recession of 2008-2009.

Volatility like we’ve seen in recent months presents opportunities for tax loss selling. As part of your comprehensive planning strategy, you and your adviser should be looking at opportunities to control the tax implications of investments in your brokerage accounts throughout the year. The financial markets don’t care if its January 1 or March 12 — taking losses might make sense on either date or neither date. It takes an active investor to take advantage of this strategy during volatile markets. While it is last minute, it’s not too late to take losses in 2022.

Even if you don’t make moves until next year, consider looking at your liquidity needs for 2023 or beyond. With the gains made in 2020 and 2021, you may still have stocks to sell that would allow you to secure those profits into fixed-income investments for the future. The recent declines may provide you opportunity to sell other positions that have a loss that could offset those long-term gains.

You’ll want to pay particularly close attention to your cost basis in your shares. You may have share lots with different cost bases if you have been dollar cost averaging throughout the year or if you’ve acquired shares through dividend reinvestment. By keeping track of the actual cost for each lot of shares, you should be able to specify the higher-cost shares to sell and increase the amount of your realized loss. Keep in mind, you cannot sell shares for a loss and buy the same stock within a 31-day period before or after the sale, as the wash sale rules disallow it, invalidating any tax loss.

The current volatility can also be a good reason to rebalance. Energy stocks had another record year in 2022, up nearly 60% this year — on top of its 53% gain from 2021. Rebalancing your portfolio allows you to trim the outperformers and lock in those gains and buy some underperformers at a discount. Furthermore, with a rebalanced portfolio, you should be able to better manage your risk when there is likely more volatility ahead.

When you own individual stocks that were purchased by dollar-cost averaging throughout the year, you generally have more opportunity to manage your tax situation. With the trend toward passive investing, some investors may have put their money in an index exchange-traded fund. While they likely experienced gains around 18% in 2020 and nearly 29% in 2021, now that the market is experiencing downswings, there is little they can do to take advantage of the losses as the overall market remains above those 2020 levels.

Keep in mind, your tax strategies should not undermine your financial goals. Tax considerations should not be the deciding factor of whether to sell an investment. But if you are able to minimize your tax liability through tax loss selling, market volatility can present a solid opportunity to do so.