Why You Need to Consider This Important Planning Strategy During Market Volatility




Many are asking whether now is the right time to be getting more aggressive with their investments after the large downturn we saw in the market in March and continued volatility since. The S&P 500 Russell 2000 Small Cap Index are still significantly below their all-time highs from February this year. As we all know, it is better to buy low over the time, so the question we need to ask, is the market cheap right now? Based on Price to Earnings ratios, the forward P/E of the S&P 500 is currently at 22.1, which is higher than it was in February when it was at 18.6 and higher than it was heading into the 2008 Economic Crisis[i]. Based on those standards, the market is not cheap. That doesn’t mean it can’t go up as the market is not the economy and they can be very disconnected as the market is thought to be more forward looking – what are earnings going to be 6-12 months and longer down the line. The economic data, on the other hand is backwards looking, telling you what has already occurred. If the investors believe that the data is going to get significantly better in the near future, the market can go up while the economic data is bad.


This is the narrative I believe we are currently in. Many believe that as the economy opens back up again, that demand will bounce back to similar levels as before and that corporate earnings will recover quickly. This could be the case but I have my doubts. See our latest Market Update video to get more information on why we are concerned about how fast the economy will bounce back and why we remain cautious. Historically, Bear Markets last 1.3 years – we are currently only about 2 months into this which I believe is too early to be sure that we are out of the woods just yet.


While we remain cautious and recommend keeping some cash to be available for opportunities, it doesn’t mean that there are not strategies you can be considering right now to improve your overall financial picture.


Roth Conversions


Roth Conversions can be a challenging conversation as it requires those taking advantage of this strategy to intentionally pay more taxes now. In the 18+ years I have been advising clients, not a single one has raised their hand to increase their bill to the IRS. However, Roth Conversions are worth considering for 2 important reasons that have collided recently.


The first is the change in the law regarding the ability to do a Stretch IRA. Previously, non-spouse beneficiaries of your IRA could take Required Distributions from their Inherited IRA over their lifetime, allowing them to spread the tax burden over a very long period and minimize their annual taxes. This has been changed to required that all funds be distributed from Inherited IRAs within 10 years. This will require a much shorter amount of time to force out IRA funds that will be fully taxed as income. This makes Roth IRAs as potentially more attractive to leave to your heirs. While they would still be required to take the funds out within 10 years, there is no tax consequence to them as the growth inside a Roth IRA is tax free.


The second major event has been the Coronavirus shut down and market volatility. While we still believe there is more market volatility to come, if we do believe the market will recover over the long run, where would you prefer those gains to accumulate: in your pre-tax Traditional IRA or in your Roth IRA? Another consideration is the future of taxes. We were already in severe budget deficits and the stimulus programs will only add significantly to that. Would you bet on taxes going down, staying the same, or going up in the future? While we can’t know for sure, it would at least make sense to diversify your future tax burden by shifting some assets to a Roth IRA through a conversion. One last benefit to consider doing this now is that if you are a business owner that has lost income due to the shutdown or an individual that has been furloughed or just chosen to retire, now may be a good time to complete the Conversion as your taxes are likely to be lower this year which would allow you to convert without as much tax exposure. One important consideration is that it is ideal to be able to pay the taxes required from the conversion with cash that is not in your IRA so that the full amount of the conversion can be invested to take advantage of the tax free growth.


Every situation is different and it is important to review the risks involved before implementing this strategy. First, the amount converted is considered taxable income in the year you complete the conversion. This could move you into a higher tax bracket and reduce your cash position that might be needed for other emergencies and opportunities. Another risk is that the market doesn’t recover, but actually goes down once you make the conversion and you now owe taxes on a larger converted amount than you have invested in your Roth IRA. For example, if you convert $50,000 and the market drops by another 20%, your Roth Conversion account would be worth $40,000. However, you would owe tax on the entire $50,000. The good news, if this situation arose, is that you could re-characterize your conversion and move the funds back to your Traditional IRA prior to your tax filing deadline and not owe taxes on the transaction. Another potential risk is if taxes do not go up in the future, but instead go down. In this scenario, you have paid taxes on the conversion at a higher rate and could have potentially paid fewer taxes by taking distributions from your Traditional IRA over time.


Business owners and successful families regularly ask me to review whether they are making critical mistakes or missing out on opportunities. The Roth Conversion is definitely not for everyone but is a strategy that should be reviewed as a part of a regular Stress Test of your financial picture. Let me know if you are interested in a free diagnostic to determine if a Roth Conversion is right for you.


Past performance is no guarantee of future results. An investment in any security involves significant risks and any investment may lose value. Refer to all risk disclosures related to each security product carefully before investing.

[i] All P/E Data is sourced from I/B/E/S data from Refinitiv

Homer Smith | 3010 Harborview Drive, Suite 202, Gig Harbor, WA 98335 | (253) 236-7000

David Stuehling | 2754 NW Crossing Drive, Suite 204, Bend, OR 97703 | (541) 210-5600 

 Investment advice offered through Integrated Financial Partners, doing business as konvergent wealth partners, a registered investment advisor.