How I made a strategic tax-related mistake and what you can learn from it

December 23, 2021 0 By admin

As the end of the year approaches, I always recall that I have to review my portfolio closer to the end of November and decide what to do with my laggards.

You may ask "why"?

This is the time of the year when investors are looking to reduce the tax impacts on their portfolios. To do so, they take advantage of "tax-loss harvesting".

When I sell laggards in my portfolio, I realize losses and use them to offset realized gains and dividend income. This can reduce my overall taxation when I file the tax return in the coming months.

There is one technique that all taxpayers including large investors use if they want to hold the stock that has dropped to the negative territory but the one they still want to hold long-term (either for long-term growth or due to nice dividends).

They buy the same number of shares of that stock before November 25-28 and sell original shares after 31 days right before the end of a year.
The result would generate the "sell" event that will reduce your tax but still preserve the stock you want to hold.

Why 31 days? Because of IRS requirements and so-called "wash sale". In plain English, if you buy the same stock earlier than 31 days, the IRS folks will not write off your loss, you like it or not.

Since I have learned this technique, I have looked at my portfolio and have made a few purchases on November 23rd to double the amounts of shares on my laggards.

So, I have bought similar numbers of shares for COIN (cryptocurrency stock) and HQH (healthcare stock). And I intend to sell the original shares on December 27th.

The first one has a good prospect of increasing in value over the long term as a cryptocurrency is gaining popularity, and the second one is a good dividend stock that delivers 8.18% yearly (as of today).

COIN: 16 shares x $346 (original purchase) - sell on December 27th

COIN: 16 shares x $316 (new purchase)

HQH: 275 shares x $26.71 (original purchase) – sell on December 27th

HQH: 275 shares x $24.15 (new purchase)

It looks like the right strategy, isn’t it?

Except for one factor that I did not consider.

All mutual funds, hedge funds, and the other big institutions (like Fidelity, Vanguard) employ the same technique AT THE SAME TIME of a year. And not only that: the laggards are being sold without buying the same number of shares with a plan to buy them back at the beginning of January 2022 or forgetting about laggards completely.

When almost the entire U.S Market is selling the laggards, what could happen?
It can lead to artificially created lows for otherwise excellent securities. December will often see "losers" performing even worse.

This can also lead to what is commonly called the "January Effect". This effect is the historical pattern that the market and stocks often rise more in January than any other month in the year. And the tax-loss selling helps explain this. The market dipped in December due to tax avoidance practices, and in January this cash is flowing back into the market, prices rise as buying pressure outweighs selling pressure.

Now, what has happened with my two laggards today? Let’s see.

COIN: 16 shares x $346 (original purchase) is now $257.66 -unrealized loss 25.66%

COIN: 16 shares x $316 (new purchase) is now $257.66 - unrealized loss 18.59%

HQH: 275 shares x $26.71 (original purchase) is now $24.66 – unrealized loss 7.69%

HQH: 275 shares x $24.15 (new purchase) - is now $24.66 - unrealized gain 2.11%

As you can see, my COIN stock has lost even more since my second purchase (an additional 18.59%!), and it means that my original purchase has lost the same 18.59%! It is painful, man…

However, my HQH stock’s second purchase has gained 2.11%, and it means my first purchase has gained the same percentage but I can still write off a 7.69% loss.

What is the conclusion and what can you learn?

While my initial strategy seemed to be right, the factor I did not consider is that the end of November and December is a time when people sell the laggards at the same time.

If you've ever worked a 9 to 5 job, you know what happens when "everyone" is trying to get to the same place at the same time! The market is no different. When the big and small investors are trying to sell at the same time, prices fall more than they should.

So, the COIN stock was hammered but I have been luckier with HQH.

The first conclusion is to adjust the dates when I am buying the same amounts of shares and when I am selling the laggards. I believe, the middle-end of October would be the right time. So, I am setting the calendar reminder. If I would do it in October, I would not lose so much with COIN and maybe gain more with HQH.

Since my goal is to buy low, and, when all the shareholders looking for an exit, they are providing us an opportunity to go the opposite direction. Especially since these shareholders are selling for personal tax reasons, which have nothing to do with the company's long-term health or its ability to pay a dividend!

So instead of participating in the "normal" tax-loss selling season time, we want to be active buyers of this season. The prices of many growth and dividend-paying securities are artificially depressed due to selling for tax purposes and not due to the company's fundamental performance. At times, these external pressures present a small window of opportunity.

And this is a second conclusion.

As one fellow said, two months of selling and buying will not ruin a company's ability to pay reliable dividends for your portfolio.

The irony is that you can do it not only in October but during a year, any month, just make sure you remember about 31 days delay or you will be losing a tax advantage with a “wash sale”.

TIP: I use another tax-avoidance "play with the dividend stocks only. In most cases, the dividend stocks pay quarterly, so I have about 90 days to sell the laggards (and trigger some write-off) and buy them later at least after 31 days since the sale.

Take a break from watching your stocks.

Often, investing in the market can feel like a full-time job without the benefits and health insurance! It shouldn't. Constantly watching the value of your investments spin with the market can be intimidating and electrifying all in one day.

Once you've taken advantage of the opportunities that tax-loss selling season offers, take a deep breath and take a break from the market.

Find some winter activities you love and enjoy them. Go skiing, snowboarding, or ride a sled down a hill! You'll become very popular with your children if you do that. If you're not the outside type, enjoy a fire in your living room fireplace with a two-fingers glass of bourbon or a cup of coffee, and turn on your favorite Hanukkah or Christmas music.

The bottom line, the investment shouldn't be about watching your money every second of every day. Forget about juggling stocks, trading in and out to pick up a few pennies of profit here and there. Focus on the income and make changes in your portfolio that will increase your income. You will find that you don't have to stress about every rotation of the market because you know that your portfolio is producing the income you need to enjoy your retirement or supplement your earning.

The tax-loss selling season is a story of two investors. One is desperately selling shares to reduce their tax burden and locking in losses. The other is the smart income investor, happily buying highly discounted shares knowing such yields will only last for a short time.

Happy investing and Happy New Year without Covid!

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Sources:  I have used a few sources of information, so, my kudos to the authors.

Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before following any investment strategies or rules mentioned or recommended. Please excuse any typos. I assure you that I will do my best to correct any errors if they were overlooked.