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VERSACE: Trimming investment dogs at the end of the year
Question of the Day
With more than a handful of trading days to close out 2011 and the S&P 500 once again underwater on a year-to-date basis, it’s time for investors to take stock of their portfolios to decide what companies and positions they should continue to own into 2012 versus those that should be jettisoned before we get there.
Now you may hear this and say, “This sure sounds like window dressing,” but it’s not. For those not familiar with the term, window dressing is a strategy used by mutual fund and hedge fund portfolio managers near the end of the year or quarter to improve the appearance of the portfolio/fund performance before presenting it to clients or shareholders. To window dress, the fund manager will sell stocks with large losses and purchase high-flying stocks near the end of the quarter. These securities then are reported as part of the fund’s holdings.
Rather what I am talking about is more in tune with cleaning out the dogs of the portfolio to make room and capital for new ideas, and to maximize your tax position - especially if you have booked any gains during the year. For many investors, tax gain/loss harvesting is one of the single most important tools for reducing taxes. Although it can’t restore losses, it certainly can soften the blow as an investor can use offset capital gains and therefore lower personal tax liability. Remember, a capital gain or loss is not recognized until the asset is sold.
While this applies to individual stocks as well as mutual funds, there are some rules to keep in mind. A capital gain or loss can be categorized as either short-term (one year or less) or long-term (more than one year). Securities held longer than one year are considered long-term for the treatment of any capital gains, and are taxed a maximum of 15 percent depending on the investor’s tax bracket. Stocks held less than one year are subject to short-term capital gains at a maximum rate of 35 percent depending again on the investor’s tax bracket. One key aspect of this is to match up short-term gains with short-term losses and long-term gains with long-term losses in order to reduce appropriate gain or loss. Short-term losses cannot be used to offset long-term gains and so on.
Besides proper matching, one has to remember to follow the wash-sale rule, which disallows deductions if you purchase the security within 30 days of selling it. If investors would like to repurchase the shares sold for a loss, they can do so after the 30-day wash sale rule no longer applies.
Given the wild ride of the S&P 500 this year - up 8 percent at the 2011 peak in April 29 to the Oct. 3 bottom that had the index down more than 12 percent on a year-to-date basis, not to mention recent gyrations, odds are there are more than a few positions that investors both individual and institutional are contemplating to manage their 2011 tax positions.
Some high-flying stocks that investors may have used to book gains include shares of Apple Inc., which rose from its 2011 low near $315 to peak at more than $420 in October, or Motorola Mobility Holdings Inc., whose stock rocketed higher when Google Inc. announced its intention to purchase Motorola. Companies and their respective stocks that are good candidates for tax loss selling, in my opinion, are Netflix Inc., which has fallen from near $300 in July to the current $71 or so, and Corning Inc. as the company peaked in February at more than $23 but the shares have been languishing between $12 and $15 since October.
Keep in mind that those are just some examples and you may want to review your options with an accountant or tax professional. At a minimum, I’d suggest reviewing the tax code as it relates to the Internal Revenue Service’s Form 1040, Schedule D, which is used to report capital gains and deductible capital losses.
• Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at email@example.com. Follow him on Twitter @ChrisJVersace. At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.
About the Author
Chris Versace, the “Thematic Investor,” is the director of research at Think 20/20, an independent equity research and corporate access firm located in the Washington, D.C. area. Before Think 20/20, Mr. Versace was the portfolio manager of Agile Capital Management (ACM), a thematically driven alternative investment fund. The groundwork for ACM was laid during Mr. Versace’s tenure as senior vice president of equity ...
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