In a recent article, we looked at some of the legacy that Sir John Templeton left us. Although there are many great investors and economists that have taught us, and continue to teach us, many valuable lessons, perhaps no lesson could be as insightful to us as Sir John’s primary method for building and creating long-term wealth: positioning in a down market.

Referencing again back to last week’s article, Sir John sought entry into the market at a “point of maximum pessimism.” What could have possibly been more pessimistic than when World War II broke out in Europe in 1939? Hitler had already marched into part of Czechoslovakia, and Chamberlain’s “Peace in Our Time” quote from the Munich Crisis of 1938 turned out to be a disaster. The next step was the “union” with Austria, and then on Sept. 1, 1939, Hitler invaded Poland. Obviously, investors worldwide had to be concerned as Hitler kept on marching. All investors, that is, except Sir John.

When war broke out, and everyone else thought that the stock market couldn’t get any better, Sir John started buying. He invested in 104 companies, including 34 that were in bankruptcy, and held on to many of those companies for several years. Only four turned out to be worthless, but needless to say, this was the start of a huge investment empire. At the core of our philosophy at FEG is that it isn’t just about the prices at which you buy and sell assets, but also about the tax consequences along the way.

Sir John took advantage of down markets, and thankfully, due to the Tax Increase Prevention and Reconciliation Act, or TIPRA, many investors may have a wonderful opportunity to take advantage of our current down market, as well. Let’s assume, for example, that you are a buy-and-hold investor. (For the record, this is not necessarily the best way to invest in our opinion.) You purchased $100,000 of equities in your IRA two years ago, and with special thanks to the housing crisis, you are now down around 20 percent. If you truly are a buy-and-hold investor, then you know you really haven’t lost anything until you actually sell your investment. Keeping in mind these equities are inside of an IRA, then you are already aware that you will have to pay taxes on all the money in this IRA once you choose to make a withdrawal. The question that needs to be asked now is, “What would Sir John do?”

While we can’t be sure what the master of positioning in down markets would do, a distinct and strong possibility is that he would take the opportunity to convert this IRA to a Roth IRA. In contrast to a traditional IRA, withdrawals from Roth IRA’s are tax-free. You pay taxes on the money that goes into the Roth today, but if you meet the standard requirements, when you make a withdrawal from the Roth, it will all be tax-free. This includes any gains you might accrue going forward in the Roth IRA as well. Let’s take another look at your original $100,000 IRA. It is now trading for $80,000. If you are in the 25 percent tax bracket, to complete a Roth conversion (if you qualify) you would have to pay $20,000 in ordinary income taxes to convert the IRA. These taxes would be due next spring and are out of pocket.

I know that paying taxes might not seem like a good idea right now, but let’s take a look into the future: Let’s assume that, when the credit crunch is over, the markets make a nice bull run, and the $80,000 value now grows to $150,000. When it is time to make a withdrawal, if the $150,000 had remained in the traditional IRA, and you are still in the 25 percent tax bracket, you would have to pay $37,500 in taxes, for a net distribution of $112,500. If you had already converted the IRA to a Roth IRA, you were originally out the $20,000 you had already paid in taxes, but the entire $150,000 is now tax-free. In essence, you saved yourself $17,500 in taxes by doing the conversion. The remaining variable, then, is the foregone earnings on the $20,000 in taxes now.

Down markets are great opportunities to complete Roth conversions, especially if you believe your assets in that IRA will appreciate in value down the road. For tax year 2008, not everyone is eligible for a Roth conversion. If your modified adjusted gross income is greater than $100,000, then you are not eligible. But thanks to the Tax Increase Prevention and Reconciliation Act, anyone can convert an IRA to a Roth IRA in 2010, regardless of income level. For the first time, many wealthy Americans will have an opportunity to invest in a Roth. But TIPRA goes one step further to make these conversions even more attractive in 2010: Taxpayers making conversions in 2010 will have the option to pay all the taxes on the conversion in 2010, or average the taxes owed on the conversion over two years, i.e., in 2011 and 2012.

In 2010, everyone will qualify for a Roth conversion. But assuming you are eligible for a conversion now, should you do it? The primary considerations should be the value of your assets today versus what you think they will be in 2010 and your tax bracket today versus what you think it will be then. Don’t forget the huge consideration in this equation, which is that tax rates are scheduled to go up early next decade. Be sure to see a member of our team or another financial professional to help you with this process, but remember to ask yourself: “In this down market, what would Sir John do?”

Joseph “Big Joe” Clark is a certified financial planner and the managing partner of the Financial Enhancement Group, LLC. He is a registered principal offering securities and Registered Investment Advisory Services through World Equity Group Inc., member FINRA/SIPC. Big Joe can be reached at bigjoe@yourlifeafterwork.com, or (765) 640-1524.