Here are strategies you can implement during market declines to improve your situation

Unless you are invested in a small selection of stocks that are in favor amid the surge in economic and financial market uncertainty this year, you likely see discouraging numbers when you look at your account balance today.

That doesn’t mean that you should avert your eyes from your finances. There are strategies you can implement during market declines that can improve your situation and set you up to capture more of the eventual recovery.

In addition to re-evaluating your long-term financial plan and continuing to buy even when it feels uncomfortable, consider the following two methods to respond to declining investment values.

TAX-LOSS HARVESTING

In non-retirement accounts, where capital-gains taxes are applicable, you have the option to sell investments that have declined in value compared to your cost basis (purchase price plus additions). Selling shares of the investment turns an unrealized capital loss into a realized capital loss that can be used to offset capital gains elsewhere. Capital gains are generated when you sell an investment that has increased in value and also when mutual funds that you own distribute their capital gains to you. You can eliminate capital-gains tax by pairing the gain with an equivalent amount of loss. If your losses exceed capital gains, then you can use up to $3,000 of capital loss to offset ordinary income and can carry over any excess loss to future years.

For example, assume that you have $7,000 of realized capital gains by year-end, and you have the option to sell an existing investment that has a $10,000 capital loss. If you make this sale, rather than owing tax on the $7,000 of capital gains, you neutralize the gains tax. Assuming the 15 percent capital-gains tax rate that applies to most people, you eliminate $1,050 of tax due. (Aside from the 15 percent capital-gains tax rate, there is a 0 percent tax for low-income individuals, 20 percent for some and 23.8 percent for high-income taxpayers). Up to $3,000 of capital loss that was not used to offset capital gains, can then be used against ordinary income. Assuming a 20 percent effective ordinary income-tax rate, that saves another $600 of tax due. This example creates $1,650 of tax savings. Many investors will have larger losses that could now be utilized to generate more tax savings.

Selling an investment that has declined in value would force you to overcome a behavioral bias of many investors – loss aversion. Many people prefer not to acknowledge a loss and desire to hold the investment until it recovers. That could happen, but it’s possible that you could receive the tax benefit and invest in something similar that has a higher probability of recovering as well.

You can’t buy back the same investment that was sold within 30 days in order to claim the capital loss, but you can buy a similar investment immediately following the realization of the capital loss to keep your money invested.

When reviewing your portfolio for candidates to sell, start first with investments that no longer fit your strategy, have poor future return prospects or can be easily replaced by a similar investment.

ROTH IRA CONVERSION

For people who expect to pass on wealth to heirs, especially heirs who are likely to be subject to higher tax rates in the future, converting some currently pre-tax IRA dollars to after-tax Roth accounts can be beneficial. With investment balances having declined, it is now possible to convert more shares to a Roth than could have been converted at the end of 2021.

When you convert pre-tax holdings to an after-tax account, you accelerate what would otherwise be a future tax to this year at a known rate. The amount converted is added to your ordinary income for the current year. It is best to have money outside of the IRA to cover the cost of the increased ordinary income taxes this year. Future growth of the investments in the Roth IRA conversion account is tax-free as long as a few rules are followed. Your heirs may even stretch the tax-free growth for up to 10 years after the year of your death before they need to make any withdrawals.

The Roth IRA conversion is a particularly useful strategy for people who have retired but not yet begun Social Security. While taxable income is lower than during working years, people in this situation can fill up lower tax brackets with Roth conversion dollars paying an attractive rate now rather than an unknown, possibly higher tax rate in the future.

This strategy doesn’t make sense for everyone but is worth reviewing to understand your options.

Utilizing ways like these to improve after-tax returns might help you generate extra dollars to spend or donate, creating something positive out of an otherwise difficult time for investment returns.