Upside to Down Market is Taxes October 18, 2008 – Posted in: Press
By GAIL LIBERMAN
Published: October 18, 2008
Palm Beach Daily News
There sure is a lot to talk about financially speaking when you hit this season’s first cocktail parties.
But instead of talking about how much you lost in the stock market recently, you might discuss the high quality stocks and bonds you own that should perform well in the future.
Or, might a more attractive conversation revolve around large, beautiful jewels?
Tobina Kahn, vice president of House of Kahn Estate Jewelers, Chicago, with an office in Palm Beach, says the tide has shifted in her shops. In September, most of the phone calls came from people looking to sell gold for cash. But since the $700-billion-plus government bailout package, private investors, flush with cash from liquidated stocks, want to invest in large jewels. Most popular: Solitaire diamond rings of three carats and up.
“I’m getting 30 to 40 calls per day,” Kahn says, noting that her estate jewelry likely has less of a mark-up than chain stores.
If you haven’t jumped ship from the stock market, though, congrats! You deserve a medal for fortitude. Plus, financial research definitely supports your cause.
By not timing the market, you likely will benefit more from the compounding of your investment return. Historically, almost 40 percent of the return on the S&P 500 index, a measure of large company stocks, is due to reinvestment of dividend income.
When you buy and hold for at least one year, you also benefit from the long-term capital gains tax rate, which is 15 percent. By contrast, short-term capital gains are based on your ordinary income tax bracket. So if you’re in the 35 percent tax, bracket, you’d pay 35 percent on profits from stocks held less than one year.
A study by the Vanguard Group, Radnor, Pa., a few years ago compares holding a stock fund for at least five years with selling it every year for five years.
Assume that two investors are in the 35 percent tax bracket and invest $10,000, which grows at an 8 percent annual rate.
The results show:
* The investor who bought and held the $10,000 in a stock fund for five years had $13,989.
* The person, who, with an initial $10,000, bought and sold the stock fund frequently for five years, generating short-term capital gains, had just $12,885.
The buy-and-hold investor made $1,104 more because he or she did not pay short-term capital gains taxes on the profits.
Of course, not everyone can buy and hold.
If your financial condition changes, you might need to sell some securities. You also might want to sell because of bad management or poor performance.
This year’s down market might be a bit unusual in that its upside is, of all things, taxes.
By selling losing securities, you can reduce your taxes, prune away unwanted securities and reposition “tax-ugly” investments, says Christopher P. Parr, senior vice president of Financial Advantage Inc., a Columbia, Md. fee-only financial adviser.
Consider removing “tax-ugly” investments, which throw off high, fully taxable dividends, from taxable accounts.
If you own, for instance, a losing bond fund or a real estate investment trust, consider selling them, and putting them in a tax-advantaged plan, such as an IRA or 401(k). Unfortunately, it won’t help to sell losing securities already held in tax-advantaged accounts, like IRAs or 401(k)s.
In taxable accounts, though, you can offset your losses with corresponding gains.
So if you have, for instance, $10,000 in long-term capital gains in an energy stock, you also can take $10,000 in long-term capital losses in another security, and they’ll cancel each other out. Beware, though, that you can’t sell an investment at a loss and buy it back within 30 days, according to IRS “Wash sale” rules.
You can take advantage of this strategy, however, to a limit of $3,000 in net losses in any one year. Any amount above that must be carried over to the next year.
Consult with your tax adviser and be sure to plan your tax strategy carefully.
For example, it could pay to consider saving some potential tax losses for next year, Parr advises. Since the top long-term capital gains rate is 15 percent, you can write off only 15 percent of your long-term losses. But if the capital gains rate were to increase to, say, 20 percent, as presidential candidate Barack Obama proposes, those losses could become one-third more valuable.
Did you have big losses this year? If so, that’s all the more reason you might wish to wait until 2009 to sell some losers, he suggests.
Gail Liberman is co-author of several books with her husband, Alan Lavine. Their latest, published by Que, is ‘Quick Steps to Financial Stability.? You may e-mail her at MWliblav@aol.com.