Monday, December 25, 2006

Stupid Year-End Tax Advice

Of all the year-end tax tips I see bandied about in the popular financial press, the one that I disagree with most is the advice to sell stocks in your portfolio that have declined in value in order to generate tax losses that can offset capital gains you might be reporting for that year.

I cringe whenever I see an article entitled "10 Year End Tax Tips" or "Seven Ways To Cut Your Tax Bill Next Year," because nine times out of ten, the writer suggests that you "sell your losers."

This advice shows up here (, here (, here (, here (, which presents the advice a little bit more responsibly), here (, here (, here (, here (, here ( and in basically every single year end tax planning guide you will ever come across. These year-end tax tip articles usually have the same incestuous few bits of advice that, although they might be helpful in some situations, generally aren't worth the paper or pixels they're printed on.

So why do I call the particular suggestion of selling losers "stupid advice?" Because you should always base your decision to buy or sell a stock on the price of the stock and your estimate of the company's future prospects, not on how the other stocks in your portfolio have performed.

If you own shares of a company, and the value of your investment falls below where you purchased it, you need to reevaluate your investment. Is the company still performing how you thought it would? Has there been a negative change in the fundamentals of the business or its industry? Has the stock simply fallen out of favor? Are investors getting scared? You sell your stake in the company when the fundamentals have changed and your original reasons for buying it no longer apply, and this shouldn't be something you wait until the end of the year to decide on.

If you based all of your financial decisions purely on lowering your tax bill, I could give you some great year-end advice. Tell your employer to stop paying you for your work. This will put you in a lower income tax bracket (the 0% bracket, to be more specific) and ease next year's tax burden. Then take all of your income-generating investments, liquidate them, and put the proceeds into a 0% checking account. This will reduce the interest income you have to pay. Also, try to contract a serious disease or injure yourself so you can deduct all of those huge medical bills.

Hopefully you realized the previous paragraph was me being sarcastic, but the point that I am trying to make is that you should not base your investing decisions purely on the tax consequences because in many cases, the tax benefit of offsetting some capital gains would be more than offset by the future performance of the stock. You are taking a very short-term view when you sell a loser to offset gains, and I would argue that if you're going to make short term bets on stock prices, you might as well go to the nearest casino and at least get some free drinks while you gamble your money away.

In some cases, the advice to sell losers might make sense. If you haven't been paying attention to your portfolio all year (and if you haven't, why are you investing in individual stocks in the first place?), this might give you a reason to reevaluate your holdings. If you're on the fence about selling a stock due to its business prospects, all else equal this consideration might push you over the fence.

Finally, I am not a tax advisor, so you should check with yours before making any decisions with the intention of lowering your tax bill. The preceding was just my sound, educated, correct opinion and does not necessarily reflect the views of the personal finance industry, the blogosphere, or the world as a whole.


taxxcpa said...

Those year-end tips are always the same. The time to sell a stock is when you think it is not a good investment or you need the money to buy a better stock.
Spending money to save tax is like paying a dollar to save a quarter.
Often the best thing you can do is to defer taking a deduction until the next year; e.g. take the standard deduction this year and double up on your property tax next year.
For more of my ravings, go to:

MoneyMan said...

"Paying a dollar to save a quarter." Great way of saying it.

I didn't know it was possible to defer your property tax (but then again I don't own a home so there are a lot of things I don't know about that). I will have to look into that and check out your blog.