As the world slowly starts to emerge from the recent recession - which has affected more people, across more industries, across the world, than any in recent history - there are certain opportunities that investors can take to mitigate some of the damage. The following are five things you can do to take advantage of the current downturn in the stock market.

TAX LOSS SELLING

The government has been bailing out quite a few companies lately. Insurance companies, banks and automobile companies have been given money by the feds to help straighten things out.

Individual investors can get their piece of the pie, too, and here's how: Even with the recent stock market rally, equities are still down 30 percent from their highs of October 2007. Much of the gains people previously had in their investments have been severely reduced, with some gains even turning into losses. Now is the time to sell those stocks, and convert those "paper" losses into realized losses.

This can be done because the Internal Revenue Service allows taxpayers to offset realized gains and losses, with the net amount being reported on their tax returns. If realized losses exceed realized gains, then taxpayers can take up to $3,000 of the net loss on their current tax return, with the balance of the loss being carried forward to future years. That $3,000 loss will then be used to reduce one's taxable income. For a taxpayer in the 25 percent bracket, for example, the government will give the taxpayer, through a reduction of their income taxes, $750.

TAX LOSS HARVESTING

While the government currently only allows taxpayers to deduct the lesser of net realized losses or $3,000 in any one tax year, the amount not deductible can be carried forward for use in future tax years. With income tax rates likely going up in future years, the value of these carried-forward losses will increase.

One objection that people have to selling investments at a loss is that they ultimately would like to continue to own those stocks. The good news with tax loss harvesting is that the investor can buy back the stock 31 days after the sale and still report the loss on their tax return. Under normal economic conditions, being out of the stock for 31 days should not have a material effect on the price at which it is repurchased. For those who do not want to be out of the stock for 31 days, one solution would be to buy either a stock in the same industry whose price tracks to the original stock, or a mutual fund that invests in the industry the stock is in.

PORTFOLIO REBALANCING

A downturn in the stock market is a good time for investors to rebalance their investment portfolio. Rebalancing a portfolio involves selling asset classes that are now a greater percentage of the portfolio than originally planned, and buying asset classes that are now less than the original percentage that comprised the portfolio.

This selling high and buying low is exactly what an investor should want to do with a portfolio. Not only does it keep the portfolio from becoming over-concentrated or under-concentrated in a particular type of investment, but it also reduces the risk that a downturn such as the one we just experienced will destroy the portfolio.

The knock against rebalancing too frequently is that it can cause adverse tax consequences by selling investments with gains. With the stock market decline, the tax consequences have probably been reduced substantially, so for many investors that should be less of an issue.

CHANGE INVESTMENTS

While fear of paying a large tax should never be the reason to hold onto an investment, there usually is resistance when advisors recommend selling the investment and paying the tax. This is commonly seen with people who own stock in the company that employs them. However, the consequences of owning too much of one stock or investment is far greater than the tax that would be owed.

Now is a good time to sell those investments. Again, with gains being reduced or eliminated, the tax bite certainly won't be as big. As discussed above, an investor may even receive a tax benefit from the transaction.

Further, for those people who invest in mutual funds, there may be a hidden reason to switch funds. Mutual funds are required each year to distribute to their shareholders their proportionate share of any net realized gains by the mutual fund. Any net realized losses that the mutual fund may have are not distributed to shareholders, and instead are carried forward to future years. Switching from one mutual fund to another with realized losses that have been carried forward can help minimize taxes for the investor going forward.

Mutual funds now report their capital gain and loss exposure percentages for investors to see. Switching to a mutual fund solely because it has large capital loss carryovers can be dangerous. These carryovers may be due to the downturn in the stock market, but may also indicate that the fund manager is underperforming as well.

DOLLAR-COST AVERAGING

Dollar-cost averaging new money into investments in a down market allows the investor to buy more shares of their investments than if the market had never gone down. If the investor believes that ultimately the market will recover and reach levels it would have reached at some point in the future, then dollar-cost averaging will result in more shares of the investment owned at that future point in time (and therefore a greater value of those investments).

For example, let's say that the stock price of XYZ Co. increases 10 percent a year for 10 years. If you bought the stock at $10 a share, it would be worth $25.93 10 years later. If you were to buy $1,000 worth of the stock at the beginning of each year, then you would have accumulated 714 shares at the end of 10 years.

Dollar-cost averaging also allows investors to find a bright side to severe drops in the price of stocks that later recover, because the same amount of money will allow them to buy even more shares of the stock at the time of the drop.

No one likes to see the value of their investments go down. The reality, however, is that they do, and most assuredly will again in the future. However, when this happens, the investor can take some of the sting out of the downturn by employing the strategies mentioned above.

Howard Hook, CPA, is a certified financial planner with Access Wealth Planning, with offices located in Roseland and Princeton, N.J. Reach him at hhook@awplan.com.

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