Here are four concrete things you can do to take advantage of lower prices of stocks now that the stock market has fallen.
1. Buy more stocks. If the growth potential of stocks seemed great when prices were higher, arenâ€™t they an even better deal now? You should continue to contribute to your 401(k), 403(b) or other retirement plan at work. You may also be able to contribute to an IRA or to a Roth IRA. When you buy stock investments now through those retirement or other plans, you will acquire more shares per dollar invested of the companies or mutual funds than when prices were higher. If and when prices return to previous or even higher levels, your investments will be worth correspondingly more money.
2. Take a tax loss. If you have an investment not in an IRA or retirement plan that has fallen below your purchase price (plus reinvested interest, dividends and capital gains) and you sell it, then you have a capital loss. You can use that capital loss to offset present or future capital gains. You can also deduct $3,000 against your taxable income each year. And you can carry any unused capital losses over to future years until they are used up. Be careful, though. If you reinvest the proceeds in the same or a â€œsubstantially similarâ€? investment within 30 days after the sale, you will not be able to use the capital loss right away.
If you sell an investment at a low price and reinvest the proceeds right away in a different investment, you may also be purchasing at a lower price. Of course, if the investment is truly different, its price movements will also be different.
3. Convert your IRA to a Roth IRA. If your adjusted gross income is less than $100,000, you can convert your IRA to a Roth IRA. This works best if you have the cash already set aside to pay the tax on the IRA distribution. Why is this a good time to do this? When the market has fallen, your IRA is worth less, so your taxes from the conversion are less than they would be if your investment were higher priced. In the year 2010 you will be able to convert your IRA to a Roth IRA no matter how high your income is. But the tax cost would be higher if the IRA has increased in value.
4. Make a stock gift to relatives. You can make a tax-free annual gift of up to $12,000 per donor and per recipient. If prices are lower, you can give more shares of stock without bumping into the annual limit.
These are your chances to make lemonade from lemons. Make sure that you talk with your tax advisor if you are not sure how these ideas will impact your taxes and financial situation.