Real Life Resources

Tax Strategies: Turn A Loss Into A Gain

People don’t like to lose money on their investments, but tax-loss strategies can help ease the pain. Here’s how to win even when the stock market goes against you.

The Price of Performance

The financial reports you get online or through the mail may flash a big percentage gain, but that number may not tell the whole story. Some points to ponder:

  1. Stock or mutual fund performance statistics usually reflect pre-tax gains or losses.  But investors have to pay taxes on capital gains.
    1. Bragging rights are one thing, but the money that goes in your pocket is another. The gain you book is usually less than the headline number.
    2. Extensive research revealed that the average mutual fund investor in a 35% tax bracket gave up a hefty 20% of the 6.66% annualized gain over a 15-year period ending in 2010.
  2. Strategies like tax-loss harvesting are not just for the wealthy. Find out how they can work for you.
    1. Be proactive. Sit down with your financial professional once or twice during the year to discuss tax planning, instead of waiting until December to dump your losers at the same time as everyone else. All that selling drives down the price. Ouch!
    2. The stock market always has ups and downs, so strategize with your financial team to see if market fluctuations can be used to your advantage.

Do the Math

A few simple calculations show how tax-loss harvesting works. In this example, we’ll add some fizz to portfolio results with two imaginary soft drink stocks.

  1. Assume you bought one share of Orange Soda at $100. It fell by 50% to $50 but you held onto it until it rose back to your original purchase price of $100. Then you sold it.  Since you sold it at the same price as you bought it originally ($100), there was no capital gain and thus no capital gains tax. You just broke even (excluding trading costs).
  2. Now let’s bring tax-loss harvesting into the scenario:
    1. When Orange Soda goes down from $100 to $50, sell it.  If you are in the 20% tax bracket, you are entitled to reap 20% of that $50 loss: $50 divided by 5 is $10.
    2. Next take the $50 you got from selling Orange Soda plus the $10 tax loss benefit and invest the $60 total in one share of Cherry Soda.
    3. If Cherry Soda doubles to $120, you will realize a capital gain of $60 upon selling it ($120-$60 = $60). After paying 20% capital gains tax of $12 — $60 divided by 5 — you will have $108 left, an $8 increase over your original $100 investment. That was easy!
    4. By substituting one Consumer Staples stock for another the portfolio allocation remains essentially the same, too.
  3. Using this strategy for 100 or 1,000 shares can certainly refresh your returns. And if you’re in a higher tax bracket, the profits rise even more.

Of course, it’s not necessary for the everyday investor to grasp every nuance of sophisticated tax strategies before looking into them further. Talk to your financial adviser to see if they might add fizz to your portfolio.

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Gerstein Fisher
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