You may have heard that “you should ride it out since the market will come back.” The question is will all of your investments come back, or will some of the stocks and mutual funds you own disappear as a result of the recession? “Buy and hold” no longer looks like a brilliant strategy, given the financial difficulties and failures of some of our oldest institutions. One thing history has taught us from past recessions is that companies usually do not survive if they are not tops in their industry have weak financial fundamentals (too much debt, poor cash flow, etc.) and are poorly managed.

You need to take action now by thoroughly analyzing all of your investments whether in a 401K, IRA, etc. When you consider that many economists predict that our current recession is probably one of the worst since 1945, the risks of blindly hoping for the best when it comes to your investments are far too high.

The primary goal of a thorough analysis of your investments is to determine which stocks and funds to hold and which to sell. Research will have to be done for each one of your holdings. This will entail studying the financial statements of each company including all footnotes and research reports as well as obtaining the latest news about the company and information about sales and its competitive position. In addition, you need to study the holdings of each of your mutual funds to see where there is duplication. Why own different funds that hold the same stocks and increase your risk exposure?

Once this information is digested, a decision to hold or sell each stock and mutual fund will need to be made. The goal is to curtail additional losses in the stocks and funds you own that may not rebound.  Some of the cash generated by selling poor performers can be used to purchase investments with promise. This may sound risky given the current economic climate; however, the time to buy is when assets offer a sizeable long-term return. Just think, once the market shows a consistent rebound, investors who cashed in will jump back into the market and drive stock prices to higher levels. How will you then make up for the losses you’ve take. So while it may not be the right time to dive back into equities full throttle, you need to begin your search for solid investments that will likely rebound. 

Another benefit of this exercise will be the impact on your income taxes. By selling stocks with gains you can lock in your profit and offset those gains by selling stocks with losses. This will save you money since you will not have to pay a capital gains tax on the stocks sold with gains. You can buy back any of the stocks sold after 30 days. Stock losses in excess of stock gains may only be deducted up to $3,000 each year. If you have a total net loss that is more than the yearly limit, you can carry over the unused part to the next year and carry it over to later years until it is completely used up.

Next, you need to review your investment portfolio to ensure that you have the proper asset allocation for your age and risk tolerance. For example, should you have 70% of your portfolio in equities? A more conservative allocation, given the current economic climate, might be 50% in stocks and the balance in fixed income instruments such as CDs, bonds/funds, depending on your age and risk tolerance. You’ll need to also remember to periodically rebalance your portfolio to maintain your desired asset allocation.

Call me for a confidential discussion about how you can recoup your losses and rebuild your portfolio.

By Joseph A Sclafani, CPA/PFS, MBA, Registered Investment Advisor, AICPA Personal Financial Planning Specialist and Tax Consultant is president of Potomac Financial Advisors, LLC a registered investment advisory firm in Ellicott City Maryland.