Investing Archives - Page 2 of 2 - Legacy Wealth Advisors

For the past decade, we’ve enjoyed a relatively robust bull market. There have been some small ups and downs, but the market has largely continued to go up. This was the longest-running bull market in history, and many investors felt as though it would never end.

Of course, as financial advisors, we knew that today would come. The market always cycles back to a bear market eventually and, unfortunately, this past week the Dow Jones Industrial Average fell more than 20%. This indicates that we’re officially in a bear market due to a number of factors, including the impact of COVID-19 on the global economy.

Many investors feared the coming of a bear market, and are now concerned about its long-term impact on their goals. However, in finance and life, there’s a season for everything. The key is to know potential strategies to leverage this particular season to your benefit. During a bear market, there may be several financial moves you can make to help set yourself up for possible future success. One of these moves is to consider a Roth IRA conversion.

What is a Roth Conversion?

In a Roth conversion, an investor converts their Traditional IRA or 401(k) to a Roth IRA. Traditional IRAs and 401(k)s are tax-deferred. In other words, they’re funded with pre-tax dollars now, but Required Minimum Distributions (RMDs) and other distributions that you take out during retirement are subject to income taxes.

Many people contribute to tax-deferred accounts to build their retirement nest egg – and it’s no wonder why! Lowering your current taxable income can have many benefits, and the prevalence of tax-deferred account options through employers makes them easy to access. However, a Roth IRA can be equally beneficial. Roth IRAs aren’t funded with pre-tax dollars. Instead, you contribute to them with funds that have already been taxed. So, when you reach retirement, taxes aren’t owed on any qualified withdrawals you may make.

Investors can perform a Roth conversion by transferring their funds from a tax-deferred account to a Roth IRA. They will, however, owe taxes on the funds that are transferred in the tax year the conversion took place. Still, for many who expect their income to continuously grow over the course of their career, paying income taxes now as opposed to later (when they may be in a higher tax bracket) might make sense.

Why Convert Your Roth in a Bear Market?

In our current bear market, we’re experiencing a market sell-off. While markets are down, and tax brackets are lowered due to the Tax Cuts and Jobs Act, you could convert to a Roth IRA and potentially pay notably less in income taxes than you would during a bull market. Essentially, you’d be paying taxes on a much smaller portfolio, which could save you money in the long run.

Regardless of whether or not you choose to convert your tax-deferred account now or later, there will still be a cost associated with the conversion. Even though the cost of converting may be lower during a bear market doesn’t necessarily mean it’s the right decision for you. For example, if you don’t have the funds to cover the taxes you will owe (without tapping into the newly-converted account), a conversion may not be in your best interest.

As is the case with any financial decision, we believe you want to make sure you get the best possible deal. Although it may not be wise to make decisions about Roth conversions solely based on the market, it can be useful to work a negative situation in your favor when possible.

The truth is that, when the markets are down, investors may be fearful and want to pull out of the market completely. However, it can be more beneficial to seek out ways to make lemonade out of lemons when it comes to your financial strategy.

Have Questions?

We are here to help! If you have questions about whether or not now is the right time to perform a Roth conversion, we’d love to hear from you. Contact us today to set up a conversation with our team of advisors. Together, we can help to build a retirement strategy that meets your unique financial needs.

^{Advisory services are offered through Legacy Wealth Advisors, LLC dba Legacy Wealth Advisors, an Investment Advisor in the State of Michigan. The information contained herein should in no way be construed or interpreted as a solicitation to sell or offer to sell advisory services to any residents of any State other than the State of Michigan or where otherwise legally permitted.}

^{All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication or future results. Moreover, this material has been derived from sources believed to be reliable but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed. Legacy Wealth Advisors does not offer tax planning or legal services but may provide references to tax services or legal providers. Legacy Wealth Advisors may also work with your attorney or independent tax or legal counsel. Please consult a qualified professional for assistance with these matters.}

Exchange-traded funds (ETFs) have taken the investing world by storm. By allowing investors access to a diverse range of asset classes across the stock market for relatively low-costs, ETFs are providing investors with a new array of possibilities for their investment strategies.

So what are exchange-traded funds and how can they impact you? Let’s take a closer look.

Basics of an ETF

ETFs are a collection of securities (stock, bonds, commodities.) pooled together in a single entity. They hold a diverse range of securities ranging from national to international stocks, bonds, and commodities across industries and specialties.

ETFs often track an underlying faction of a market index, investment holdings that represent a particular section of the financial market. Shares of these pools of securities are then available for sale and traded on major stock exchanges.

Unique to ETFs are the way that they are traded. An ETF is available for trade like an individual stock, on exchange. This means that an ETF can be traded all day while the market is open and active, allowing the price per share to fluctuate as they are bought and sold.

This characteristic separates them from a mutual fund that is only priced and traded once per day when the market closes, making an ETF a more flexible form of investing. ETFs issue and redeem shares on an ongoing basis which constantly changes the number of shares available. This practice keeps the market price of the ETF in line with its underlying securities.

Now that you have a basic understanding of how ETFs work, it is time to take a look at how they can impact your portfolio.

1. Increased flexibility

Since ETFs are traded like stock, they allow for more flexibility in trading shares. This feature gives the investor more control.

ETFs also offer many different investment opportunities such as:

Bond ETFs: this could include a range of government, corporate, and municipal (state and local) bonds.
Industry ETFs: this type of ETF focuses on securities for one or related industries such as oil, technology, gas, etc.
Commodity ETFs: this type of ETF hones in on a particular product/commodity such as gold or natural gas.
Market ETFs: the most common, this type of ETF tracks a specific index such as the S&P 500.
Currency ETFs: this type of ETF allows investors access to invest in foreign currencies.

All of these spaces give investors more opportunities to invest in markets that they might not otherwise have had access to. Since there are so many different channels for investing in ETFs, it is important to take a look at the type of securities that will balance and enhance your portfolio to help you reach your goals.

2. Lower minimums

Another important difference between an ETF and a mutual fund is that ETFs have lower investment minimums, giving more people the opportunity to invest. With an ETF, the minimum is only based on the price of a single share. It is important to know that this market price can fluctuate anywhere from tens to hundreds of dollars depending on the ETF. Not all ETFs are structured and priced the same and there is a large range between costs.

A mutual fund operates in a different way. The minimum for a mutual fund isn’t based on the price per share of the investments, rather it is a flat fee. As an example from Vanguard, most of their mutual funds have a $3,000 minimum.

3. Diversification

Since ETFs grant investors access to securities across multiple categories and industries, they are often seen as excellent ways to add diversification to your portfolio. Diversification is an important way to manage portfolio risk by balancing asset classes throughout different industries and commodities.

Even though ETFs can be used as a method of diversification, that isn’t always the case. Some ETFs hold securities that are aligned across one industry, market or commodity which might not provide the range you are looking for. If, for example, you invest in an industry-specific ETF, you may have securities that align with one type of industry such as oil. If that industry isn’t doing well, then your entire ETF will feel the burden of that.

Before you select an ETF, be sure that you know the type of securities it holds and how that fits into your diversification needs.

4. Lower average costs

One of the main reasons why ETFs are such a popular form of investing is that they often have much lower costs for investors, opening up the market to people who didn’t think they could afford to invest.

Instead of purchasing $100 for a share in an individual stock, for example, that $100 for a share in an ETF will give access to a variety of stock and underlying securities. This gives investors the ability to have access to multiple stocks at a lower cost than buying each stock individually.

ETFs require just one transaction to buy and one to sell, cutting down on broker fees and commissions. Many ETFs have fewer individual trades which also helps to minimize broker commissions.

Since most ETFs track an index, they typically have much lower expenses. This passive management makes the cost to manage the fund much lower since the broker isn’t as involved in buying and selling shares/holding within the fund.

But that isn’t always the case. Some ETFs are actively managed, increasing the number of trades, commissions, and therefore the overall cost of the investment channel. Be sure that you know how your ETF is managed and weigh the pros and cons to determine which style will be best for your needs.

5. Tax-friendly

ETFs are, in general, a more tax-efficient form of investing when compared to a mutual fund. For starters, the investor has more control over when their actions will trigger capital gains tax, unlike with a mutual fund.

Nearly every year, investors of a mutual fund receive their share of the fund’s transactions (buying and selling of shares) in the form of a capital gains distribution. This distribution can be cashed or reinvested in the fund. But no matter which option is selected, the investor is responsible for paying capital gains tax on those distributions. This brings about regular capital gain tax whether the investor sells shares or not.

As you start to think more about ETFs, we encourage you to ask yourself a couple of questions:

What is the ETF you want to invest in designed to achieve?
How does that product align with your goals as an investor?

Your portfolio should reflect your values and goals for the future. Take some time to think about what those goals are and how employing different investment strategies can help you reach those goals in an effective way.

It is our goal at Legacy Wealth to help you plan and reach your financial goals and investing is often a big part of that picture. Investing in a way that makes sense for you and your finances is one way we help our clients reach their goals. Schedule a 15-minute call with us to learn more about ETFs and if it will be a good fit for your investment strategy.

Roth Conversions in a Bear Market