It’s a little late in the day to be writing about this topic, which is perhaps indicative of my ambivalent attitude toward the idea.
Professional portfolio managers, by and large, don’t pay much attention to tax selling, for several reasons:
–we’re trained to think that tax considerations are much less important than company fundamentals in making buy and sell decisions,
–many of the portfolios we manage are tax-exempt–in fact, clients sometimes stress to us that they’re indifferent about whether profits come as ordinary income or capital gains,
–company fundamentals are way more important
–most professionals spend all their time watching their clients’ money, not their own.
Tax considerations aren’t nothing, though.
Mutual fund managers have always got to keep an eye on the size of the profits they generate, since virtually all of the have to be distributed as taxable gains to their shareholders. In addition, for many individuals, investment gains–either through their own active management or from distributions from mutual funds or ETFs can be a significant source of (taxable) income. So they’ve got to be at least aware of how big that income is.
…for individuals like us
As an individual, I have four general thoughts:
1. I live in a state, New Jersey, where the state taxes on investment gains are very high. So I try–earlier than the last day of the year–to flatten my gains by taking losses.
2. Combing the portfolio for losers forces me to consider carefully any security that is below my cost. I often find that the process forces me to recognize that the fundamentals of a given security are bad (we’re all good at deceiving ourselves in this regard). So I end up selling for fundamental reasons. The search for tax losses is only the occasion, or the trigger, for my sale. In some cases, the loss can be an ego-saving excuse. In my view, that’s the main value of the process.
3. As peculiar as it sounds at first, a loss has a financial value for a taxable investor. It’s the ability to shelter gains on other investments from taxes. For a losing stock that has little purpose in a portfolio, recognizing that value sooner than later is probably wise.
4. Not selling a stock because you have a big capital gain is an easy–but sometimes painful–mistake to make. So I have to do a sanity check on winners, as well.
I have a friend who had a very large inherited position in GE when it was a $40+ stock in 2007. At the time, I wasn’t a fan of GE. I thought Jack Welch was a brilliant self-publicist who had convinced the financial press that hamburger was filet mignon and who had left Jeff Immelt a horrible mess to clean up. My view of Mr. Welch hasn’t changed; my respect for Mr. Immelt has grown.
My friend said she felt she couldn’t sell because she depended on the dividend income from the shares. She also said she had a cost basis of only a couple of dollars, so taxes would take huge bite (25% or so) out of her capital. Since then, however, GE slashed its quarterly payout from $.31 to $.10–it has just been raised to $.17–and the stock now sells for $18.
In hindsight, it would have been a lot better to at least diversify away from GE and pay the taxes. (An unbelievably gutsy investor could have bought the stock back for less than $6 in early 2009, but stuff like that never happens in real life.)