The Best Trade You Can Make in November

by Alexander Green, Investment U Chief Investment Strategist
Thursday, November 24, 2011: Issue #1650

In December 1996, I sold some shares of Best Buy (NYSE: BBY) to offset gains elsewhere in my portfolio.

I still consider it the most boneheaded investment move I ever made. A year later, the stock was up more than five-fold. A few years further on, it was up more than thirty-fold.

The worst part is that I didn’t dislike the business prospects for Best Buy at the time. Quite the contrary, in fact. I sold it only because I had substantial capital gains and was cleaning out my portfolio to offset them.

I don’t always do that any more. And you shouldn’t necessarily, either. Despite what your tax advisor may tell you, you should never sell an investment for tax reasons alone. Nor do you have to.

Here’s why…

The IRS allows you to offset realized gains with realized losses each calendar year. If you do, however, you must wait at least 30 days before buying the same shares back. (Otherwise you run afoul of the wash-sale rule.)

Offsetting gains at the end of the year is often a sensible move. Most stocks aren’t appreciably higher 30 days later. And if you still like them, you can buy them back then.

There is a risk, however, and it’s called the January effect. The first month of the year is traditionally a strong one for the market. A lot of pension and IRA money gets invested early each year. Plus, there’s often a rebound from the tax-loss selling that goes on each December.

If a stock you own soars in January, there’s a natural reluctance to buy it back. The temptation is to wait until it comes back down. But what if it doesn’t? You’ve taken a limited loss but sold an investment with unlimited upside potential.

There’s a way around this problem, however. And you can take advantage of it – but only if you’re willing to move this week.

In late November each year, I look at my entire portfolio for any companies that are trading below my entry price but NOT near my trailing stops. If I still like a stock, I often make the decision to double down on it for 30 days.

Why? Because I can sell the original shares at the end of December for a tax loss. And if the stock rallies in January, it’s not a problem. After all, thanks to my purchase in November, I own the same number of shares as I bought originally.

What if you don’t have the cash to double down on your position? Use margin. Again, I’m recommending this only for a 30-day period. Your margin interest charge will be minimal.

The risk, of course, is that your shares will be worth less in late December and you will have a paper loss on the second purchase.

However, just the opposite may happen. Remember, the January effect is often preceded by the Santa Claus rally, the tendency of the stock market to do well in the second half of December. As a result, you could end up with a smaller loss in your original shares and a paper gain on your second purchase.

(The Santa Claus rally is never certain, of course, and another reason why you should only add to those companies whose earnings prospects remain strong.)

Bear in mind, when selling for tax purposes, the IRS requires that you buy those identical shares AT LEAST 30 days before you sell the others. So if you want to use this strategy for 2011, you must act this week.

If we have the traditional mid-December to early February rally, you’ll thank me. And then perhaps again on April 15.

Good investing,

Alexander Green

Best BUY Co. Inc., Business/Finance, Capital gains tax, Chief Investment Strategist, Economics, Finance, Financial economics, investment, Short, Stock, Stock market

How to Keep More of What You Make

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, October 25, 2010: Issue #1373

Last week, I met with a tax advisor who said something a bit ominous – but also true, I think:

For the rest of our lifetimes, income and capital gains tax rates will never be lower than they are today.

This is a bit startling when you consider that tax rates aren’t particularly low right now. Income, in particular, is taxed at up to 35%, compared to 28% when Reagan was in office.

When you add in Social Security taxes, unlimited Medicare taxes and an average state income tax of 6%, federal and state governments may take up to half of what you earn.

Of course, the Obama Administration is itching to let the Bush tax cuts expire and allow the top marginal tax rate to rise another 13% (to 39.6%).

Thanks to the fiscal crisis that Congress has created over the past decade, tax rates are likely to keep rising in the months and years ahead.

Clearly, you need to take whatever actions are permissible to keep as much of what you’ve earned as possible. And for investors, that starts with tax-managing your portfolio…

Effective Tax Management in Five Easy Steps

Here are the five basic steps to tax-managing your portfolio properly:

• Use Your Retirement Account: Whenever possible, use your retirement account for short-term trading activity. That way, your short-term gains – rather than being taxed at the same level as your income – compound tax-deferred.

• Less is More: You should minimize trade turnover in your non-retirement accounts. As Warren Buffett once pointed out, “The capital gains tax is not a tax on capital gains, it’s a tax on transactions.”Hold your winners for at least a year, if possible. If you do, you’ll qualify for long-term capital gains treatment at the maximum rate of 15%. (This may change after January 1.)

• Offset Capital Gains: The IRS allows you to offset all of your realized capital gains with realized capital losses. And you can take up to $3,000 in additional losses against earned income.

• Use Tax-Deferred Accounts: Use your IRA, pension, 401(k) or other tax-deferred accounts to own corporate and Treasury bonds (since interest income is taxed at the same rate as earned income) and real estate investment trusts (since REIT dividends are taxed the same way).

• Use Index Funds: If you invest in mutual funds, use index funds rather than actively managed funds in your non-retirement accounts. Index funds tend to be highly tax-efficient since changes to benchmarks are rare. Managed funds often have high turnover and Federal law requires them to distribute at least 98% of realized capital gains each year. You can get hit with a big capital gains distribution even when you haven’t sold a share – and even if the fund is down for the year.

Take these steps and you’ll substantially lessen the government’s tax bite. The few remaining choices are simple ones – for example, owning tax-free rather than taxable bonds, especially if you reside in a high-tax state like New York or California.

An Artful Solution to Cutting Your Taxes

The 1995 Tax Act also allows you to donate – to any IRS-approved charity – works of art at their fair market value, not their cost basis.

Moreover, you can deduct the charitable gift’s fair market value on your tax return without being subject to the dreaded alternative minimum tax.

Pillar One Advisor Mike Kuschmann works closely with published artists and sometimes acquires limited edition prints or serigraphs at a substantial discount to their current market value.

As Kuschmann explains, “Clients of mine purchase them far below published cost – often for just a few thousand dollars – and later donate them to a local hospital or university at fair market value, allowing them to save thousands of dollars in federal taxes.”

For more information, contact Mike Kuschmann, president of Fine Arts Ltd, at: 800-229-4322 or 407-702-6638. He’ll send you a complimentary brochure pack explaining his services and detailing the tax savings available.

Over the next few weeks, I’ll highlight several other year-end tips for reducing your tax liabilities.

Because – remember – it’s not how much you make. It’s how much you keep.

Good investing,

Alexander Green

Business/Finance, Capital gains tax, Finance, Flat tax, Income tax, Income tax in the United States, Jobs and Growth Tax Relief Reconciliation Act, Political economy, Public economics, Tax, Taxation, Taxation in the United States