Tax Loss Selling as a Way of Trading Underperforming Shares
Tax loss selling is a strategy for trading shares and securities at a loss, with the aim of reducing taxable income. Investors usually sell stock that has declined in value to offset gains or profits. This is usually done at the end of the financial year so that the amount of loss reduces income for tax purposes.
Tax-loss Harvesting and Benefits
Taxes increase for a number of reasons. The authorities may increase the statutory rates or payroll tax may increase when an employee is promoted. Some individuals and companies donate to charities while others opt for different methods.
In general, this strategy is used by companies and individuals who own stock in mutual funds. The payout comes in different forms, be it long- or short-term capital gains, interest, or dividends. There are some rules that savvy investors follow. For example, the wash-sale rule forbids deduction for the sale of shares that were bought 30 days before the day of the sale. In fact, deduction is not allowed 30 days after and before the sale of securities. This rule is designed to avoid speculative trading that aims to avoid taxation. Different rules apply for substantially identical securities. If an investor buys and sells Toyota stocks, he is trading securities that are substantially identical. The situation is different when the investor buys IBM stock and sells Intel stock. To benefit from this strategy, it is important to sell stock and buy similar but not identical stock. This is also a good strategy for losing securities.
Benefits of Selling Securities
In addition to reducing taxable income, this is a strategy to diversify one’s portfolio. Investors can sell their underperforming securities, especially if they have traded a few securities through a non TFSA or RRSP account. This is a beneficial strategy for investors with large realized gains. Here is an example how it works. An investor buys 1,500 shares of company A on April 1, 2012 at $8 per share. He sells 1,500 shares of company A on November, 1, 2012 at $9 per share. The capital gain is $1,500 ($13,500 - $12,000). Then the investor buys $1,200 shares of company B on January 1, 2013 at $8 per share. He sells $1,200 shares on November 1, 2013 at $7 per share. The capital loss is $1,200 while the taxable gain is $300 ($1,500 - $1,200). Keep in mind that this can be a risky strategy, and timing is important. Shares that have not performed well for an extended period of time may suddenly increase in value.
On the other hand, almost any investment portfolio includes underperforming stocks. Studies show that over 40 percent of stocks in portfolios are not performing well. Savvy investors identify losing stocks and sell them to offset their capital gains liabilities. Funds are usually diversified, and it is not as easy to identify underperformers. In fact, only 3 – 4 percent of all funds report losses, which makes it difficult to spot losing holdings. Cherry-picking is one strategy. For example, an investor buys 300 shares at $22, then 300 shares at $14, and another 300 at $11. The stock is selling at $16 in 6 months. One option is to sell the first lot and keep the other two. This way, the investor sells losing stocks and realizes a capital loss. Then he can buy stocks of other companies, which is a good way to diversify one’s investment portfolio. It is recommended that novice investors check with their tax or financial advisor to see whether this strategy makes sense for them.
Mutual Funds Pool - a Selection of Investment Instruments
A mutual fund is a financial instrument that invests in different types of securities. They invest in money market instruments, bonds, stocks, and different share classes. Classes and Investment InstrumentsInvestors can choose from class C, B, and A shares. The last type has a front-end sales load...
Bond Funds as a Way to Invest in High-Grade Securities
Bonds funds invest in debt securities such as convertible, municipal, corporate, and government bonds. They also buy mortgage backed securities and other investment solutions. The main benefit for investors is that they are paid higher dividends compared to money market instruments and certificates...
Choosing Between High-Risk and Investment Grade Corporate Bonds
Corporate bonds are issued by companies or corporations and bought by investors. They are backed by collateral or the company’s ability to earn income from its operations. They carry a higher interest rate because they are riskier than other types of debt instruments. Characteristics and TypesThis...