3547: Taking Advantage of Mr. Bear by JL Collins on Market Downturn Investing

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[00:00:30] This is Optimal Finance Daily, Taking Advantage of Mr. Bear by JL Collins of JLCollinsNH.com. Today, March 9th, 2020, I decided it was time to cuddle up to Mr. Bear and let him help me avoid some capital gains taxes. As regular readers here know, for the past few years, we have been homeless and nomadic. It's a lifestyle that agrees with us and one we'd like to keep doing for some time.

[00:01:00] However, at some point, age will force us to settle down. The trick is deciding when exactly that is. Act too soon and we miss out on extra wandering. Wait too long and I might not have the energy left to easily make the transition. But sometime in the next five years, there's a better than even chance that we'll be buying a final year's house. To that end, we've had money growing in a taxable account invested in, of course, VTSAX.

[00:01:28] As I tracked this against the eventual sale to fund the house, I realized that we'd be on the hook for a 20% capital gains tax until at least this new market sell-off. Suddenly, that capital gain was disappearing. Indeed, with an 8% drop today, it would be completely gone. So with the market down about 6.34%, figuring that we'd be close enough, I put in the sell order and moved from VTSAX to our money market fund.

[00:01:58] Conveniently, by the market's close, it was down 7.6%, almost exactly when I needed. Good luck that. So with this sale, I now have the capital freely available and will owe little to no capital gains tax. At the same time, I then sold an equivalent amount of VBTLX bonds and bought VTSAX stocks in an IRA. Because this was done in an IRA, there's no tax consequence.

[00:02:24] The net effect is that I have moved bonds from the IRA and stocks into it, again while freeing up money for the future purchase with no capital gains tax to be paid. At the end of the day, our asset allocation remains the same. This is not a bet that the market has bottomed. Q&A Wouldn't you have been better off if the market had continued to rise, even if you had to pay the capital gains tax?

[00:02:51] Of course, but as I learned playing poker, you play the cards you're dealt, not the ones you wish you had. If I had a crystal ball, I would have sold before the drop and happily paid the tax. But I didn't. This market decline simply offered an opportunity, and I took it. I'd prefer the market never went down, and I always could sell at a gain. The market doesn't care about my preferences. Why not wait to see if the market drops further?

[00:03:17] That way, you not only avoid the capital gain, but get to harvest a capital lost. I want to preserve as much capital as possible for the future purpose. Selling at break-even is the sweet spot for this gambit. Doesn't this run afoul of the IRS wash sale rules? My thanks to the several readers who raised this question, and especially to John R., who suggested I add it here. This was my reply to James, the first who raised this question. Wash sales apply to selling at a loss.

[00:03:46] From the article you linked to, quote, This ruling provides that if an individual sells stock or securities for a loss and causes his or her IRA or Roth IRA to purchase substantially identical stock or securities within a specified period, the loss on the sale of the stock or securities is disallowed under the section 1091 of the code,

[00:04:13] and the individual's basis in the IRA or Roth IRA is not increased by virtue of section 1091D. End quote. In my case, the objective was to sell at break-even with neither a loss or a gain. Because life isn't perfect, there will likely be a small gain or loss when the dust settles, but it'll be too small to worry about. Why did you move into a money market fund rather than bonds with VBTLX?

[00:04:40] Mostly because it was easier and I wanted to get the order in before the market closed. I might move it to bonds later. Wait, but aren't bonds best held in an IRA? Ordinarily, yes. But remember, this was done to free up capital from stocks for potential future spending. Money you intend to spend in the next five years or so is best held in cash, which is what a money market fund is. Or bonds. Planning any further moves?

[00:05:07] As noted in the addendum to my last post, when the market was down about 15% on February 28th, I moved some VBTLX to VTSAX. If the market continues to drop, I'll do more of that. Taking advantage of drops like this are what bonds are for. Isn't this scary? No, wrestling a grizzly bear in your garden is scary. But this time is different, right? Nope.

[00:05:34] Every market drop feels like this time is different. Someday, if it truly is, nothing will matter, least of all how you're invested. Example, 1963. Brink of nuclear war between the USSR and the USA. A truly civilization-ending possibility. Great time to buy. No war. Market goes up. War. Market doesn't matter.

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[00:07:53] I always seem to have a fangirl moment every time a JL Collins article is in the queue, and today was no different. What I like about this article is that he didn't change his financial plans in light of the huge drop we saw earlier in 2020. He just took advantage of the opportunity. JL was already planning to buy this house and sell these stocks eventually, so the drop just enabled him to do so without having to pay the capital gains tax.

[00:08:19] If you can hear the cool, calm, collected tone to this article, you're not imagining things. That's really what he sounds like. Do yourself a favor and Google a guided meditation for when the stock market is dropping. This hilarious but also helpful guided meditation reminds you why you shouldn't sell out of fear, and it's a great resource during inevitable bear markets. If you think you'd enjoy the soothing, deep baritone voice of JL Collins,

[00:08:49] I highly recommend you find that meditation on his YouTube channel. But that'll do it for another episode of Optimal Finance Daily. Thank you for being here and sharing the show with someone, and I'll catch you tomorrow on our next episode, where your optimal life awaits. You're welcome.