Wealthy investors approach market downturns differently. Here’s what we can learn from them
Nobody cheers when the stock market goes down—especially when bonds are crashing at the same time. But the ultrawealthy are different from the average investor: They have access to financial advising strategies that limit their losses—and even help them take advantage of opportunities that come with a bear market. “Most of my clients see this period as an opportunity,” explained Georgia Lee Hussey, the CEO of the progressive financial advising firm Modernist Financial.
From investing in private credit to tax loss harvesting to converting to a more sustainable stock portfolio, the top 1% is not complacent during the market meltdown. Here’s what they’re doing—and how you can benefit from what they already know.
Stay the course
Seasoned investors know that the stock market is cyclical. Hussey explained that her clients remind themselves that stock market lows are historically normal. “[Historical perspective] is one of the biggest differences that I see between earlier investors and investors who have a fair amount of experience,” explained Hussey. “For example, I have a client who is 80, and the current inflation and rising interest rate market is not bothering him at all,” she explained. “The first thing that my high-net-worth clients do is that they can put the noise within context, and usually just ignore it.”
Advisers noted that it is rare that both stocks and bonds have tanked in tandem this year. “This situation is different from [past stock market lows] because it’s been a slow and seemingly continuous bleed down in both stocks and bonds,” explained Vance Barse, founder of wealth strategy firm Your Dedicated Fiduciary. Especially younger generations of investors have not witnessed a decline in both stocks and bonds at the same time, Barse noted. “It becomes a conversation of behavioral psychology and really understanding that the immediate needs have been met, and that markets do in fact go down.”
Focus on what is “on sale”
For investors looking to accumulate stock, now is the time. “Everything is on sale,” Hussey said.
Benjamin Trujillo, a senior adviser at the Moneta Group, also noted that many of his clients are “taking advantage of the discount” right now. “They’re taking a cautious approach, but many are putting money into the market.”
However, it’s a matter of debate whether equities have further to fall before climbing again. As Fortune‘s Shawn Tully reported in late May, “Equities can thrive again. But the math shows that they’ll have to fall a long way from here before investors will get a genuine buying opportunity.” Today the price-to-earnings ratio of the S&P 500 is 19.29, compared to 24.1 at the index’s peak at the end of 2021.
Shift from traditional to sustainable investing
Hussey says many clients are using the downturn to shift from traditional to environmental, social, and governance (ESG) investments. ESG investing encompasses companies that are considered environmentally sustainable and socially responsible, and that operate ethically. For many of Hussey’s clients, while sustainability is a priority, capital gains taxes would normally be prohibitively high to transition an entire portfolio of stocks to companies that have favorable ESG ratings. A bear market is the best time to transition your portfolio, because when valuations are depressed, investors can make strategic transitions with their portfolios at a lower capital gains tax rate. “We have been waiting for the market to go down,” she said. “If the value of everything is down 20% and I need to convert the stock portions to ESG investments, it is cheaper for me to do it now.”
For any investor interested in investing in sustainable stocks, a company’s ESG rating can be found on research firms’ lists, such as the S&P Global ESG Risk Atlas.
For investors who plan to give stock irrevocably to a trust, a bear market allows them to give higher amounts of money at a lower tax rate. Barse noted that many of his clients are thinking about giving in the context of the lifetime gift tax exemption that is set to last until 2025. “If you could give away $5 million irrevocably to satisfy part of the utilization of the lifetime exemption, you want to satisfy that with an asset that is now at a valuation that is depressed relative to where it was valued on, say, December 31 of 2021,” Barse explained.
This logic also applies to giving any amount of contributions to a trust. For example, if you’re planning to give to a college savings trust and want to gift shares of stock, now is a great time to contribute while the market is down so your money will go further when the market eventually recovers.
Take advantage of a Roth IRA
Another popular move right now among high-net-worth individuals? Transitioning a traditional IRA account to a Roth IRA account. A Roth IRA account benefits investors since the money is taxed when it is put in as opposed to when distributions are taken in retirement. Unlike a traditional IRA, a Roth IRA does not have to be withdrawn within a week of retirement, so the money can continue to grow tax-free and even be passed down to another generation.
Converting traditional accounts into Roths while the market is down means you’re paying a lower tax rate in comparison to the eventual growth of the account. “The reason a Roth conversion is really important right now is because when account values are down, we’re mathematically able to convert more of the accounts,” explained Barse. “We’re able to do that conversion and get that money into the Roth account to position it for the eventual upside and recovery in equities,” he added.
Hussey explained that her clients are also taking advantage of the bear market to convert to a Roth IRA. “If your traditional IRA had $400,000 in it, and [when the market goes down] you now have $300,000, if you are converting a third of it to the Roth, that $100,000 you move are the same assets.” Hussey explained that you’ve done the conversion “on sale” because the amount of tax being paid is lower, yet the same assets are now converted to a Roth and the equities are positioned to grow when the market recovers.
However, transitioning from a traditional IRA to a Roth can result in a large tax bill, so it is important to consult with a tax adviser about your individual situation.
Regardless of whether you have a Roth or traditional IRA, now is also the right time to make retirement contributions, according to Barse. “Make your 2022 retirement plan contributions now so that those assets can be deployed during the sell off that we’re currently in,” he said.
Watch for tax loss harvesting opportunities
Barse explained that clients should seek out tax-efficient investing through tax loss harvesting. Tax loss harvesting is a strategy in which investors sell some specific investments at a loss when they are selling other stocks at a gain in order to lower capital gains taxes.
While some mutual funds utilize tax loss harvesting, others do not. Barse recommends prioritizing tax-efficient investments. “By using this as an opportunity to harvest losses on expensive investments that are tax-inefficient, that can be replaced with much lower costs and more tax-efficient holdings,” he explained. “All prudent planning starts with a solid understanding of the client’s tax return profile.”
Look to unload real estate
Trujillo noted that some clients took advantage of the inflated real estate market over the past two years to sell property. “We have some very high-net-worth clients who are taking advantage of the high real estate market to liquidate real estate,” he said.
Hussey explained that she has told her clients to put off buying and renovating real estate for the time being. “I’ve been telling people not to buy into the real estate market and not to do remodels on their houses. Because that market feels insane,” she said. “You’re stuck with that house once you own that house.”
While the housing market has soared over the past two years, the Federal Reserve has recently started to raise interest rates, which has slowed gains dramatically. “As April and May housing data trickled in, it became clear the pandemic housing boom was fizzling out,” reported Fortune‘s Lance Lambert. While different regions of the nation are seeing various levels of deceleration, many buyers are choosing to hold off while the market rebalances. “Overall, the best summary is that we’ll move from a gangbusters sellers’ market to a modest sellers’ market,” Ed Pinto, director of the American Enterprise Institute’s Housing Center, told Fortune‘s Shawn Tully. (You can read Fortune‘s full report on when housing prices will start to cool in 48 major metro areas here.)
To Hussey, it is worth it for her clients to wait to buy until the market cools down, even if that means paying a higher mortgage rate on a smaller loan value. “I’ve been telling people to just wait; even if they have to pay a slightly higher interest rate on their mortgage, they’re still in a position to buy a house,” she explained.
Rising interest rates also make buying individual bond issues more advantageous. “The rising interest rate market is harder for borrowing money, but it’s really good if you’re an investor and you own bonds,” Hussey explained. “Individual issues become more and more appealing as interest rates go up,” Barse noted.
Many of her high-net-worth clients, Hussey explained, are converting bond funds to individual bond ladders: portfolios made up of bonds that mature in staggered dates. The benefits of a bond ladder are that it can help create predictable income and mitigate risk of shifting interest rates. To build a bond latter, people invest in a number of different bonds with the same value that mature at regular intervals, beginning at different times.
While Hussey noted that bond ladders are not necessarily accessible to everyone, regular investors can still benefit from holding bonds right now. “Let’s say you own a Vanguard short duration bond fund, the income they’re going to receive on that bond fund is going to go up over time,” Hussey explained.
Consider professional advice
While lots of strategies can be “mimicked” by regular investors, there are absolutely asset classes that professional wealth managers can help clients access. Venture capital and hedge funds are two big areas that clients with high net worths (and long timeframes) can access. Christian Habitz, cofounder of the wealth management firm Invectus Collective, said he advised his clients to turn to private credit when the market began to decline. “[Private credit is] one asset class that has been growing in popularity over time, but very much on the institutional side and not as much on the retail side for the average investor,” Habitz explained. Private credit has a higher yield when compared with publicly traded corporate bonds. “We began moving client assets, rebalancing, using private credit as a new asset class, more than we had historically,” Habitz said. If you are on the bubble of considering professional advice, and are interested in more exotic asset classes, professional money managers can open those doors—for a fee, of course.
Crucially, every adviser I spoke to stressed that it is vital for investors to have access to liquidity so they don’t have to sell depressed assets to pay bills. Hussey explained that her clients have been building their cash positions for the past few years. “A lot of our clients are business owners. So we’ve been doing things like building line of credit opportunities for them,” she explained.
“In almost all cases, we want to make sure that the client’s immediate cash needs between now and the next 18 months are accounted for. So we don’t have to lose sleep at night over an unfavorable market environment having a deleterious impact on the integrity of a portfolio,” explained Barse.
Hussey noted that for those that do not fall into the high-net-worth category, creating access to liquidity could look like asking for credit card increases. She explained that in 2020 when the market went down, she requested increases from her credit card companies, just to ensure access to cash. However, this strategy only makes sense if you’re sure you can pay off the balances to avoid accumulating credit card debt.
In the end, perhaps the best thing you can learn from the ultrawealthy is to set your expectations realistically for the next chapter. “This market environment has not been one where we’re focusing on making money. The conversations have been about trying to lose less,” says Barse.
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