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Lessons From 2020 Are Coming in Fast

Lessons From 2020 Are Coming in Fast

| October 22, 2020

This latest one is that taxes can save people money!

This isn't going to be one of those long-winded tax minutia emails that I'm almost sure nobody reads. Rather, it is a psychological quirk all of us encounter.

Back in March, some people were understandably in a panic after the stock market lost 35%. It was a four-week stretch that seemed to last forever.

Unfortunately, some investors decided to change their risk tolerance at precisely the wrong time – they sold right near the March 23 stock market low. These investors realized they could not stomach the risk.

We do not encourage changing your risk tolerance during a big market drop, but let's not get into that today.

What we found interesting from a behavioral perspective is that many investors avoided selling stocks simply because they knew capital gains taxes would be due.

Triggering a tax bill was less emotionally desirable to many investors than further losses. We call this mental accounting in behavioral economics parlance. It can be one of the benefits of owning stocks in a taxable brokerage account versus a tax-advantaged 401(k) or IRA.

What's ironic is that by holding stocks through the February-March volatility, investors then experienced the remarkable recovery. It's as if the pain of taking a tax hit was a safety net! Unfortunately, these investors gave up on some stocks in their tax-deferred accounts.

It was a fascinating case study in how investors actually behave. After all, life does not happen on a spreadsheet. Fear & greed (and taxes!) play a big role in how we all handle our money.

So, that is how taxes can save people money sometimes. Ain't it so 2020!

Connect with us so we can help you determine your ability and willingness to accept risk – don't wait for volatility to strike. The bottom line is that panic-selling in a down market is almost always a bad idea. To make matters worse psychologically, it can also cause unnecessary income taxes.

If either of those points helps you stick with your plan, take your pick!

Thanks for taking a look!