Sell Your Losers Now- The Silver Lining of Losing Investments
The S&P 500 is up 27% so far this year, which has been a surprise considering how 2018 ended. Not all of the stocks in the index have been up, however. Some have performed quite badly.
Take Macy’s (M) for example: it is down 40% YTD! DXC Technology (DXC) is down 28%, and Kraft Heinz (KHC) is down 22%. Even my former employer, Gap Inc (GPS), has had a rough year, with a loss of 28%. As of December 19, 58 of the stocks in the S&P 500 have negative returns. If you’ve owned any of these stocks this year and are kicking yourself for holding them this long or buying them in the first place, don’t fret- there is a silver lining here.
On the one hand, it’s actually good that not all of your positions go up at the same time. Other than a reason for patting yourself on the back that you’re batting a hundred, if all your positions are up in any given period, it means they can potentially all go down at the same time. It also means you’re probably not well diversified. If your portfolio has performed well throughout 2019 and you have a few losers, that could be good. Some of the stocks mentioned above might have fundamental challenges to overcome, but generally speaking you want some stocks in your portfolio to zig when the rest of them zag.
The fact that you have a few losers also helps with reducing your tax liability. You see, if you have unrealized losses- that is, your positions are down from when you bought them but you haven’t sold them yet- then you could create a tax benefit by selling. The losses on those positions will offset any gains you have realized from winning positions, reducing your taxable income.
I know how difficult it could be psychologically to sell a losing position. It could be interpreted as admitting defeat or conceding a loss. This is very common among retail investors. Investors tend to hold on to losers expecting them to recover even when there is a good chance it might continue to decline – all in order to postpone admitting defeat.
Selling a position at a loss that could potentially continue to get worse is a sound investment decision, but what about selling positions at a loss that you might still feel positive about? That’s where tax-loss harvesting and understanding the wash-sale rule can be combined.
Tax Loss Harvesting and the Wash-Sale Rule
First, let’s get rid of all those positions that have unrealized losses for the year that we think are less likely to recover. Chalk it up as a learning experience and move on. We lost. We were wrong. We all make mistakes. If those losses offset any gains you may have already taken in the portfolio, then that’s great- you may have reduced your taxable investment income to zero and offset those losses by saving on taxes. How do you know if those stocks will recover or not? You don’t. But ask yourself, would I buy this stock now? If the answer is no, then it’s time to sell, because if you wouldn’t buy it now after it’s down so much, you likely shouldn’t have bought it anyway.
If the answer is yes, you might want to sell it anyway- with the intention of buying it back in 30 days. Why 30 days? Well, if you sell it now to realize the loss so you can reduce your taxes, the IRS won’t allow you to buy it again for 30 days. If you do, the tax benefits will be nullified. Now, you’re probably thinking, “what if it recovers in 30 days?” I can tell you that if it’s down 35% in the last year, it’s very unlikely that it will recover in 30 days. Can it have a price increase? Sure, but the price increase you would miss is probably going to be less than the tax benefits you might get. Also, the tax benefits can be calculated and are certain, while the potential hopeful recovery in the stock is NOT.
So, while you have just a couple of weeks left before the end of the year, and with the market closed on some of those days, here is what I would do if I were you.
1. Calculate the amount of unrealized gains you have generated year to date from positions you have already sold.
2. Sell the positions with unrealized losses that you don’t think will recover and/or that you do not feel as bullish about as you did when you first invested.
3. Calculate the net realized losses generated YTD.
a. If you still have positive gains, sell some of the losers that you might be reluctant to sell because of your bullish opinion. You can buy them back up in 30 days.
b. If you have negative realized gains, determine whether they are more than $3K. The IRS won’t allow you to take more than $3K in realized losses- any losses above that amount can be rolled over to the following year so you don’t lose it.
i. If your realized losses are more than $3K and you have some positions you should be reducing as part of re-balancing, you could do that to the extent you bring your losses down to $3K.
ii. If your realized losses are less than $3K, you’re done.
4. In 30 days, if you still like some of those positions you sold at a loss, consider buying them again.
Depending on your tax bracket and assuming your positions are held in a taxable account, you could save up to 20% on the gains you have realized this year by also selling some of the losers. If you calculated a YTD realized gain of $10K, for example, you will pay up to $2K in capital gains taxes. By selling positions that will net you a $10K loss, your capital gains tax will be reduced to zero. There are other considerations, like whether they are short-term gains (held less than a year) or long-term gains- but simply put this technique, called tax loss harvesting, could save you a few thousand bucks. Not a bad Christmas gift to give yourself!
To get a great guide on capital gains and losses, head over to this link.