Broker Check

Making Lemonade out of Lemons

June 26, 2023

This has been a very challenging year for investors. The downturn in the stock market during the first half of the year represents the worst performance over the first six months in any year since 1970. While bonds have been a cushion to portfolios for 40 years, they experienced their largest quarterly decline in 30 years during the first quarter.

The current fixed income environment has created opportunities in various sectors. For example, municipal bonds may represent an excellent option for investors seeking tax free income. The steep decline in values earlier this year has resulted in a tripling of average municipal bond yields from 1.12% to a current yield of 3%. For a taxpayer in the 35% tax bracket, this yield equates to a taxable yield of 4.61%. For Massachusetts taxpayers who invest exclusively in Massachusetts municipals, the tax equivalent yield is 5% since state income taxes are waived as well. Of course investors should be aware that values could decline further if long term interest rates continue to rise.

While many clients moaned about the additional taxes they incurred in 2021 as a result of robust market returns, they are now concerned about unrealized losses this year. While investors are averse to losses, they do provide a window to benefit from tax loss harvesting. Under this strategy, realized capital losses can be used to offset capital gains. For example, earlier this year I used losses in various securities to offset gains in technology stocks as they began to falter. Capital gains can be entirely negated by an equal amount of capital losses. An additional $3,000 of unused capital losses can be deducted from ordinary income annually. If an investor remains bullish on a security but decides to sell it for the tax loss, they must be aware of the implications of the wash sale rule. The investor must not re-invest in the security for at least 30 days from the sale or the loss will be disallowed.

For investors who have contemplated converting an IRA to a Roth IRA, the current environment presents a great opportunity. With portfolio values generally down double digits, the income tax due on a conversion could be significantly reduced compared to a conversion executed last year. Investors need to be mindful that any appreciated gains from the conversion cannot be distributed for 5 years or they are subject to tax.

Finally for wealthier investors looking to advance their estate planning, they may wish to gift appreciated assets that have declined to family members by utilizing either the annual gift exclusion of $16,000 (as of 2022) or the lifetime gift exclusion of $12.06 million. While the cost basis remains with the recipient of the gift, there are two benefits associated with this strategy. First, the decreased value of assets allows for a larger tax exempted gift. Second, assuming the recipient of the gift is in a lower tax bracket, the capital gains tax will likely be lower when the asset is sold.

In summary market declines can present opportunities to accelerate investors goals and objectives. By focusing on long term analysis that applies rational and unemotional thinking, individuals may be able to make lemonade out of lemons.


Clifford L. Caplan, CFP®, AIF®