Performing A Tax Loss Selling Analysis

Since it is historically the weakest month of the year, I do my tax loss selling for taxable accounts during October. Prices tend to be weak, so you can maximize your capital loss offsets by selling any losers you have in your portfolio, and thereby minimize your capital gain tax bill the following April. This also frees up cash to put to work before the seasonally strongest six-month period for stocks (November through April).

Something else I do myself, and recommend for all of you, is to carefully analyze those stocks you sold at a loss. Don’t simply try to purge them from your memory. Instead, study them and figure out what common themes those positions possessed. That way, you can learn from your mistakes. We’re all going to make them, but it’s great if you can figure out why they didn’t work out the way you thought they would, and most importantly, use such knowledge to maximize your future investment performance.

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5 Thoughts on “Performing A Tax Loss Selling Analysis

  1. NO DooDahs on November 14, 2005 at 10:01 AM said:

    Isn’t every increase in your capital loss offsets also an increase in your capital loss? Unless the marginal tax rate exceeds 100%, how does it make you better off when the increase in credit is less than the increase in loss? I’d like to see the math on that, or know what special conditions have to hold, for that to be any betterment.

    I see just less than a year holding period as a good tax sale point. If the stock has depreciated even though it still seems like a good value proposition, and the holding period is close to one year, selling before the year works because the taxable rates are different – even though the loss may be (approximately) the same on day 363 as on day 366.

    Regardless, I think your main point was that we should examine our losses and look at the patterns, and there we agree.

  2. Chad Brand on November 14, 2005 at 10:18 AM said:

    If I had a $1 in realized capital gains for the year, I would rather have 25 cents of capital losses to offset that gain, as opposed to, say, 20 cents. That way I would owe taxes on 75 cents rather than 80 cents.

    The theory for how I can record that extra 5 cents is related to the timeframe. One might say you would be better off waiting until December to sell, as opposed to October, since stocks usually are higher in the former month. However, if I am sitting on a poor performer, that stock might not rise as much as my overall portfolio in November and December.

    I think I would be better off, on average, by selling the loser in October when others are selling (Mutual fund fiscal years end 10/31) and reinvesting the money in more attractive stocks at that time, to position myself for the year ahead.

    The stock I replaced has a decent chance of underperforming the one I want to buy over the course of November and December (since losers are sold at the end of the year and sometimes repurchased in January), so I’d be slightly worse off if I waited.

    In doing so, maybe I can sell the loser, which I want to sell anyway, at a slightly lower price to have more in total capital losses to offset my taxable gains.

    There’s no magic formula though, it’s just one person’s strategy.

  3. Chad Brand on November 14, 2005 at 10:33 AM said:

    In case you were wondering why I would prefer the additional 5 cent loss to my overall net worth in this example, when the move only saves me a fraction of that, the strategy assumes my first goal is to minimize current year taxes, as many of us try to do. Also, I could very well make up that 5 cents, and maybe more, by owning a “good” stock, instead of a “bad” stock, for two of the best months of the calendar year (Nov and Dec).

  4. NO DooDahs on November 14, 2005 at 11:40 AM said:

    That may a difference between a money manager and an individual investor. My goal in the taxable portion of my portfolio is to maximize after-tax gain, regardless of taxes paid. Hence I would rather pay taxes on $0.80 than pay taxes on $0.75, because the former is more in my pocket.

    Additionally, you are operating under several assumptions. First, you assume that because a stock has depreciated into October that it will subsequently underperform the general rise from October – December (another assumption is that the rise will happen). You also assume that the “winner” you pick *this* time will be perform better than the “winner” you picked *last* time, i.e. the stock you’re selling.

    Given the stated goal (minimizing current year taxes) and the assumptions spelled out, the strategy is good. Considering that I have a different first goal and I don’t think your assumptions necessarily hold, I wind up with a different tax strategy.

    Of course, your article’s second point (examining the losers for what went wrong) is perfectly true.

  5. Chad Brand on November 14, 2005 at 11:55 AM said:

    There is evidence that poor performers during the year will underperform at year-end, as investors sell for tax purposes, so that assumption makes sense, although not assured. The same stocks tend to rise in January, as investors buy them back if they like them, but sold for tax reasons.

    Conversely, stronger stocks from the past year do very well toward year-end as money managers “dress up” their portfolios for year-end reporting purposes. They want to show they owned good stocks when they report their entire list of holdings.

    I also assume that I will replace a stock that I sell with a better one. Investors wouldn’t want to make the move if they thought otherwise, so this assumption seems logical.

    Although they are assumptions, if they prove true over time (on average, with some exceptions expected) it is very conceivable that one would be able satisfy both goals; to minimize short term taxes as well as maximize long term after-tax returns, which is my goal for both myself and my clients.

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