How to Handle Long-Term Stock Gains in a Hot Market

This post was originally published on this site

As of the start of September 2021, the stock market has risen for seven months straight, and the S&P 500 is up over 100% since the recession we experienced in early 2020. The great news is that you might have built up some nice long-term capital gains over this turbulent period, but questions still loom. Here, we’ll look at how you might think about handling the gains we’ve seen in the broad markets over the last 18 months. 

1. Lock in long-term gains and rebalance

This should not read to mean you should sell all your stocks, but it is a good time (relative to others) to take some profits off the top. Presumably, if you’ve allowed your stocks to run since the COVID-induced market bottom in 2020, your asset allocation may weigh heavily in equities. Use the current opportunity to shift some profits to lower-risk assets — this can help keep your asset allocation in line without meaningfully harming your long-term return potential.

As an example, it’s possible that your portfolio of 80% stocks and 20% bonds is now looking more like a 90%/10% portfolio. Trimming the equities position back down to the 80% range is a sensible and risk-aware action to take while still leaving plenty of stock exposure in your portfolio. Fortunately, if you held the positions for over a year, you’ll also benefit from a preferred long-term capital gains tax rate. 

2. Use the proceeds to settle high-interest debt

If you’re carrying any sort of high-interest debt (call it anything over 4% interest), there is a good argument for taking a portion of your investment gains and settling the debt once and for all. Freedom from excess debt is one of the greatest gifts you can give yourself, both financially and psychologically. We tend to always want more from our investments, but if you’re in a position to lock in some nice gains and use them for a worthy purpose, it’s a great time to do that.

Note that this doesn’t apply to types of strategic debt — a low-interest mortgage, a 0% car loan in its introductory period, or perhaps an interest-free loan to finance a graduate degree. These are forms of strategic debt that don’t require immediate payoff, and you should take the lenders up on their respective offers. It turns out that not aggressively paying these off is the financially optimal choice — but you’ll still need to be comfortable with the idea of having some debt outstanding.

Image source: Getty Images.

3. Continue investing

One of the surefire ways to build lasting wealth is to invest at regular intervals. This is typically done automatically through a workplace retirement plan, but you can also set up recurring deposits to IRAs, 529 plans, and taxable accounts. The fact that the market happens to be at or near an all-time high is no reason to stop these deposits, unless you truly need the money now. 

You may hear throughout financial news outlets that the market seems overvalued; by many financial metrics, this is true. However, we have no idea how the market will fare over the next month, year, or decade, so your best bet is to continue investing without any regard for today’s closing prices. What will matter in the long run is that you invested money and stuck with your strategy. 

4. Don’t do anything 

Simply because the market has risen doesn’t need to prompt any action on your part. If you’re comfortable with a slightly riskier portfolio overall and would prefer to save on any long-term capital gains taxes, feel free to just let things be as they are. You’ll preserve your holding periods and will likely take advantage of further jumps higher in the future. 

When something unusual — either good or bad — happens in the market, many investors feel the need to do something. Humans have a predisposition to act, although when it comes to investing, you may be better off pretending your accounts aren’t even there. Various studies have shown that passive investment strategies are a sensible way to achieve and grow long-term wealth. 

Clean up your financial plan 

Whenever the market outperforms or underperforms for any extended period of time, you might find an opportunity to bring everything back to earth, one way or another. Nobody can ever fault you for selling at an all-time high to clean up an outstanding debt, nor can anyone fault you for ignoring current market prices and letting things ride until retirement. Whatever you choose to do, give it some thought first and always have a plan before you act.