Let the Tax Man Help Reduce Your Pain!

Why is it that we feel OK when we sell something at a profit and absolutely miserable when we sell any stock, bond or for that matter, real estate at a loss?  Why is it we don't have the same problem when we sell a gift or an inheritance at less than what the donor paid?  Each of us have our own reason for this, but in most cases, reacting to your emotions will ultimately have the wrong outcome - reduced returns and less income to spend.

Yes I know, about this time you think I am crazy.  And yes, I have personally been chastised by clients and their tax and financial professionals for adopting a portfolio management process to minimize taxes over time.  You would think this would not be the case, yet it is for a very simple reason - you have been taught that a loss is not a loss until it is recognized on the 1040.  You have been taught by your financial advisor to sell your winners and "average down or hold" your losers because they surely will come back.  But more importantly, you are hard-wired through thousands of years of generational conditioning to avoid a situation that causes fear.    

Avoidance is never the solution to the management of your portfolio.  Yet avoidance seems to be the norm for all investors today.  We don't open our brokerage statement.  We don't open our retirement plan report.  We turn off the TV news when they start talking about the market.  Or we do just the opposite, we look in great detail at our statements and say to ourselves "As soon as the price gets back to what I paid for it, I'm going to sell and never, never invest again".   Neither of these approaches should be the course each of you take. 

There are many reasons to sell an investment.  But loss aversion should never be one of them.  In fact, the IRS helps us reduce the pain of loss aversion through certain tax rules.  These rules allow you to offset $3000 a year in capital loss (losses from the sale of a stock, business, real-estate investment and other capital investments) against ordinary income like your salary.  In addition you can off-set any capital gains, dollar for dollar, with a capital loss.  Not only can you offset those capital gains this year, but you can continue to offset your future capital gains and a new $3000 a year until 100% of your losses are used up.  Using up these losses against future gains can increase your after-tax returns from ½ to 1 ½ percent a year.  Over time this will have a big impact on your money.  Here is a little math to help.  Say your portfolio value today is $100,000.00 and in the future you earn 8% doing what you are doing today.  Over a 20 year period, that $100,000 will grow to $466,095.71. That same $100,000 growing at 9.5% would grow to $614,161.21.  That's $148,065.5 more in your pocket by simply taking a little action to minimize your taxes.   Obviously, we are making many assumptions in this example, but you get the point. 

One last thing, tax planning needs to be done twelve months a year and the management of your portfolio should incorporate this approach.  You can be assured that we are doing this on your behalf.