07.08.14

Wealth Management Group Newsletter – Summer 2014
Steven Lewis

Making the Best of a Capital Loss
Steve Lewis, CPA

Depending on whether you have a “glass half empty” or “glass half full” mindset, you might consider incurring a capital loss to be an unfortunate part of investing or an opportunity to lower tax liability and reposition your portfolio, respectively. While no investor wishes to experience a capital loss, being able to save some taxes can ease the sting.

On the Bright Side

A capital loss occurs when you sell a security for less than your “basis,” generally the original purchase price. You can use capital losses to offset any capital gains you realize in that same tax year, even if one is short term and the other is long term.

When your capital losses exceed your capital gains, you can use up to $3,000 of the excess to offset wages, interest and other ordinary income ($1,500 for married people filing separately) and carry the remainder forward to future years until it is used up.

In with the New, Out with the Old

Years ago, investors realized it was often beneficial to sell a security to recognize a capital loss for a given tax year and then — if they still liked the security’s prospects — buy it back immediately. To counter this strategy, Congress imposed the wash sale rule, which disallows losses in situations where an investor sells a security and then buys the same or a “substantially identical” security within 30 days of the sale, before or after.

Waiting 30 days to repurchase a security you have sold might be fine in some situations, but there may be times when you would rather not be forced to sit on the sidelines for a month. Likewise, you might hesitate to double up on a position in which you have a loss and then wait 31 days to sell the original stake — a strategy that also avoids a wash sale violation because the purchase occurs more than 30 days before the sale.

Fortunately, there may be another alternative. With a little research, you might be able to identify a security you like just as well as, or better than, the old one. Let us assume you own stock in a networking equipment company that has lost value since you purchased it. After researching the industry, you discover that the company’s chief competitor is more attractively valued and has better growth prospects.

Your solution is now simple and straightforward — you simultaneously sell the stock you own at a loss and buy the competitor’s stock, thereby avoiding violation of the “same or substantially identical” provision of the wash sale rule. In the process, you have added to your portfolio a stock you believe has more potential or less risk.

The same strategy can be applied to mutual funds. In that case, your advisor can help you identify a mutual fund or exchange-traded fund with a similar investment sector, strategy and size.

Advantageous Times

If you purchased shares of a security at different times, give some thought to which lot can be sold most advantageously. The IRS allows investors to choose among several methods of designating lots when selling securities, and those methods sometimes produce radically different results.

If you are buying mutual funds, it pays to know when the next capital gains distribution will occur and how large it will be. If the distribution is sufficiently large and the date is imminent (they often occur in December), you might want to delay your purchase to avoid incurring a sizable tax liability. At the same time, bear in mind that prior dividends paid and reinvested in mutual funds you own were taxed, and therefore increase your tax basis in the fund.

Seek Professional Advice

Given the volatile financial markets of the past few years, investors know that sometimes they must sell securities that are worth less than when they purchased them. If you incur a capital loss, discuss your options to use it to reduce your taxes and reposition your portfolio with your advisor. If you need help determining if the tax strategies discussed make sense for you, please contact Steve Lewis at slewis@orba.com or call him at 312.670.7444.


Make Your Portfolio an Emotion-Free Zone
Renee Andrews-Tushinski, CPA

When it comes to your finances, emotions have their place. After all, if you never worried about the future, you would probably never buy life insurance, put money away for retirement or save for your children’s college education.

More often than not, however, emotions can get in the way of sound financial decisions. It is human nature to become greedy during good times and to panic during bad times. Because you cannot turn off your emotions, try to understand how they can undermine your investment decision making. Then, focus on setting limits that will enable you to invest successfully.

No One is Immune

Emotions can make the key to successful investing — buying low and selling high — especially difficult to pull off. Too often, they can lead investors to sell precisely when they should buy, and buy when they should sell. Investors, generally, are wired to maximize gains and avoid losses. So when stocks are on a winning streak, they may conclude the good times will never end. This can blind them to the risks of buying, say, a high-flying biotechnology stock just before it returns to earth.

Similarly, when financial markets are collapsing, the temptation is to sell as quickly as possible, perhaps shifting into investments such as cash or U.S. Treasuries just at the low point of the market, and missing out on the recovery.

It is not just novice investors who are vulnerable. Even the most sophisticated market participants are at risk, according to recent research from David Tuckett and Richard Taffler, authors of Fund Management: An Emotional Finance Perspective. This 2012 study, based on interviews with more than 50 portfolio managers, concludes that even professionals are prone to fall in love with their favorite stocks — attitudes that can prevent them from making rational judgments about appropriate times to buy and sell.

Strategies for Long-Term Results

Understanding the harm your emotions can inflict on your portfolio is half the battle. The other half is to put a process in place that can help you invest unemotionally. Here are some strategies to consider:

  • Create a Plan (and Follow it) Your advisor can help you develop an appropriate financial plan. Every investment decision you make should be consistent with this approach. By having specific goals and a strategy in place to achieve them, you will find it easier to be dispassionate about your choices.
  • Put Your Portfolio on Autopilot Setting up your investments to occur on a regular schedule — for example, monthly or quarterly — takes the timing out of your hands.
  • Maintain a Diversified Portfolio It may be the oldest cliché in investing, but not having all your eggs in one basket is an effective defense against reacting unproductively to volatile financial markets. By maintaining a broadly diversified portfolio with different types of relatively uncorrelated investments, you will be less likely to panic when conditions are challenging.

The Cost of Following Your Emotions

Somewhere in nearly every communication, you receive from your mutual fund company, you will see this line: “Past performance does not guarantee future results.” Too often, however, we ignore this time-tested wisdom when making investment decisions.

Financial research company Morningstar has compared mutual funds’ reported returns with the actual returns received by investors, with the difference reflecting buying and selling activity during the holding period. According to Morningstar’s data, the average U.S. stock fund investor lost a full percentage point of performance during the 10-year period ending Dec. 31, 2012. For investors in international stock funds, the story was even worse — investors cost themselves more than three percentage points of returns. This was true for average and professional investors alike.

In fact, it is extraordinarily difficult to know the optimal time to buy and sell stocks. Market signals create the temptation to chase past performance by buying high-priced investments while ignoring potential bargains with subpar results but better future appreciation prospects.

Know the Signs

Making decisions based on fear, greed and other gut instincts typically is a recipe for subpar performance. Ask your financial advisor for strategies to help you stick to your long-term investment strategy, or contact Renee Andrews-Tushinski at 312.670.7444.

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