Large capital gain this year

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Topic Author
henrytow
Posts: 11
Joined: Thu Oct 07, 2010 11:29 am

Large capital gain this year

Post by henrytow » Tue Mar 11, 2014 2:57 pm

I am selling some real estate with a very low basis, and thus will have a very large capital gain this year. I am a 100 percent believer in index funds, but there might be a one-time exception:

Suppose I take the proceeds and invest in a number of stocks. I can't buy 500, but the Dow would be close enough. Then wait until the end of the year. Winners I keep, losers I sell, offsetting the capital gain.

Any other ideas on how to generate capital losses?

User avatar
Peter Foley
Posts: 5007
Joined: Fri Nov 23, 2007 10:34 am
Location: Lake Wobegon

Re: Large capital gain this year

Post by Peter Foley » Tue Mar 11, 2014 3:16 pm

Rather than pick stocks, you could buy different index sectors: large cap, small cap and international. If any of them go negative you could take your loss. If none of them do, well - you are more money ahead with which to pay your capital gains taxes.

Long term capital gains are not taxed at a very high rate so I wouldn't invest with the intention of taking a loss somewhere - that is really what one is doing if buying each of the Dow 30 as you proposed.

DaftInvestor
Posts: 4842
Joined: Wed Feb 19, 2014 10:11 am

Re: Large capital gain this year

Post by DaftInvestor » Tue Mar 11, 2014 3:20 pm

I'm no expert but it sounds like your philosophy is "I'd rather loose the money in the market than pay the taxes to the government".
Personally - I'd take the money - invest it correctly - and take the tax-hit.

MN Finance
Posts: 1832
Joined: Sat Dec 22, 2012 10:46 am

Re: Large capital gain this year

Post by MN Finance » Tue Mar 11, 2014 3:23 pm

It's not a bad idea but potentially hard to implement. 1. Is this money destined for the market anyway? If not, this is a problem. 2. How much are we talking? You'll need a decent amount of money to make this work especially if there are transaction costs. 3. I would not pay attention to the DOW but rather start with the total market and work from highest market cap down and get as many positions as possible. If you can get 50 in cap weighted proportion, you're probably good.

User avatar
House Blend
Posts: 4653
Joined: Fri May 04, 2007 1:02 pm

Re: Large capital gain this year

Post by House Blend » Tue Mar 11, 2014 3:40 pm

If you go with a basket of individual stocks, there's also a market timing problem: when is a loss big enough to be worth harvesting?

If IBM is down 5%, what do you do? Exchange to cash, or to shares of HP, or wait for more losses from IBM?

Peter Foley's idea avoids that issue. If Emerging Markets is down, you can exchange from one EM fund to another slightly different one. On the other hand, indexes are less volatile than individual stocks, so the harvest might not be a bumper crop.

I would back-test your strategy against a "horrible" year like last year. Pick a basket of stocks, with prices from, say 3/11/13. How much in the way of cap losses could you have harvested by 12/31/13?

Too bad you can't pay taxes by donating shares to the US Treasury. :idea:

bobbun
Posts: 159
Joined: Thu Jun 27, 2013 2:38 pm

Re: Large capital gain this year

Post by bobbun » Tue Mar 11, 2014 3:46 pm

This doesn't seem like a good approach to me.

Consider an ETF that contains thirty stocks, or buying the same thirty stocks in the same proportion yourself. In the case of buying the ETF, gains offset losses internally, so the only loss you can realize is the net loss, if you have one. In the case of thirty stocks, you are able to realize individual losses on the stocks, and use them to offset your external gain. However, you now have gains in the stocks that remain, so really all you have done (comparatively) is to defer gains into the future. That might be useful, but consider the risk. What you have left over is less diversified than what you started with, and because of the way you "selected" the stocks that have gains, they're more likely to be systematically undiversified than some random pool of stocks. You will also have to hold these for at least a year in order to realize the same long term capital gains treatment that you're presumably receiving on your real estate deal, though you may be able to "rediversify" more quickly by buying back the stocks you sold, making sure you don't fall afoul of the wash sale rule.

Topic Author
henrytow
Posts: 11
Joined: Thu Oct 07, 2010 11:29 am

Re: Large capital gain this year

Post by henrytow » Tue Mar 11, 2014 4:34 pm

Thank you, one and all, for your answers. Perhaps I should have phrased my question more clearly. I'll try again:
I am selling some real estate with a very low basis, and thus will have a very large capital gain, about $1 million, this year. I am a 100 percent believer in index funds, but there might be a one-time exception:
Suppose I take the proceeds and invest in a number of stocks, say $5000 worth each of 50 stocks, approximately half on margin. I can't buy 500, but the Dow would be close enough. Then wait until almost the end of the year. Of the 50 stocks, some will be up, some will be down. Then sell the losers and harvest the capital losses, keep the gainers.

To answer Peter Foley, different index sectors will probably have less volatility than individual stocks, therefore less eventual losses and less eventual gain.

To answer DaftInvestor: 50 stocks should be close to the market. The Dow has 30 companies, and it tracks the S&P500 pretty closely. So I am not far off investing in the S&P500 index, with an expectation of more losses balanced by more gains.

MN Finance: Yes, I intend to add this to my existing portfolio, which is larger, and end up with Swenson's mix, with bonds in non-taxed entities. Yes, buying 50 cap-weighted is good, but I don't want to start with the highest market cap and work down else I'd overweight large caps.

House Blend: This is all in Vanguard Brokerage, so a small (>$500) is worth harvesting. The problem of backtesting is which year? One year doesn't tell me anything. To get a decent answer, I'd have to test against dozens.

Bobbun: Well, yes "all you have done (comparatively) is to defer gains into the future." That seems like a good idea to me. I already have enough domestic, foreign developed, and emerging market not too worry about lack of diversification. Indeed, my Vanguard Emerging Markets fund already is more than I want, so buying only domestic and developed is fine with me.

User avatar
ogd
Posts: 4875
Joined: Thu Jun 14, 2012 11:43 pm

Re: Large capital gain this year

Post by ogd » Tue Mar 11, 2014 4:51 pm

Henry: the problem is, you're setting yourself up for buying high, selling low. There's not a lot we can tell about future returns of anything, except that "selling losers" is one way to badly underperform. It's like taking a random series of events and selecting only those that are bad for you. In the mutual fund industry, this leads to the "behavioral gap" between the funds' returns and what their performance-chasing investors are actually making.

You could alleviate this problem by pledging to buy back the losers a month later, to allow the outcomes to go back to average. This being individual stocks though, a lot can happen in that month -- and you still have the problem of positions in stocks you ultimately don't want. Remember that loss of diversification can be thought of as an actual cost in the risk/reward ratio.

I'd only actually do this with funds, which besides diversification have the advantage that you can often find a very similar fund to buy right away when harvesting losses. A couple of things that should be wildly divergent, yet they can stay on in your portfolio if need be:

VBR -- US Small Cap value
EDV -- Extremely long-term Treasuries
VWO -- Emerging markets

, or even (gasp) gold. You can incorporate them in your AA, let them ride and see what happens at the end of the year.

Topic Author
henrytow
Posts: 11
Joined: Thu Oct 07, 2010 11:29 am

Re: Large capital gain this year

Post by henrytow » Tue Mar 11, 2014 5:31 pm

ogd writes "There's not a lot we can tell about future returns of anything, except that "selling losers" is one way to badly underperform. (Why, if I keep the winners in a almost-index? I do not understand.)
It's like taking a random series of events and selecting only those that are bad for you. (Again, I do not understand. I also "select" and keep the winners.)
In the mutual fund industry, this leads to the "behavioral gap" between the funds' returns and what their performance-chasing investors are actually making. (Why?)

If I buy 50 stocks by taking every 10th in a cap-weighted list of the S&P 500, that list should be highly correlated with the S&P 500.
If those 50 on average go up, then the worse that can happen, compared with buying the index, after selling losers is to end up with more on margin than I want. That's not bad, compared with buying the index.
If those 50 on average go down, then the worse that can happen, compared with buying the index, after selling losers is to end up with some cash. Again, that's not bad.

livesoft
Posts: 69587
Joined: Thu Mar 01, 2007 8:00 pm

Re: Large capital gain this year

Post by livesoft » Tue Mar 11, 2014 5:35 pm

henrytow, I'll flat out state that it would be idiotic to buy $5000 each of lots of stocks in order to lose money. If you are left with some winners, you have just compounded the problem and then also have a bunch of stocks that in the long term you will not want. Think about it.

Just give away a million dollars worth of appreciated index funds and be done with it.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
bottlecap
Posts: 6248
Joined: Tue Mar 06, 2007 11:21 pm
Location: Tennessee

Re: Large capital gain this year

Post by bottlecap » Tue Mar 11, 2014 5:43 pm

I'm shocked that you'd rather lose 72 cents than gain 72 cents. Why not just loan me the money and I won't pay it back? That way you can write it off as bad debt and I can pay taxes on it. I can PM you my particulars to seal the deal....

JT

ras4250
Posts: 133
Joined: Tue Mar 04, 2014 1:25 pm

Re: Large capital gain this year

Post by ras4250 » Tue Mar 11, 2014 5:50 pm

I'd be curious for any answers to OP's original question "Any other ideas on how to generate capital losses?"

User avatar
bottlecap
Posts: 6248
Joined: Tue Mar 06, 2007 11:21 pm
Location: Tennessee

Re: Large capital gain this year

Post by bottlecap » Tue Mar 11, 2014 5:54 pm

ras4250 wrote:I'd be curious for any answers to OP's original question "Any other ideas on how to generate capital losses?"
Why? My idea generates income losses, which can be deducted at your income tax rate, if I'm not mistaken, not simply the capital gains rate. You'd be much better off, therefore, losing your money to me in a bad debt, no?

JT

Caduceus
Posts: 2133
Joined: Mon Sep 17, 2012 1:47 am

Re: Large capital gain this year

Post by Caduceus » Tue Mar 11, 2014 5:57 pm

I don't think the focus should be on generating capital losses in the first place. I think you should simply invest in your asset allocation as you otherwise would and harvest any losses later this year as/when they come.

I'd love to have a million-dollar cap gains! :)

User avatar
pjstack
Posts: 1308
Joined: Tue Feb 20, 2007 5:03 am
Location: Harbor City, CA

Re: Large capital gain this year

Post by pjstack » Tue Mar 11, 2014 6:06 pm

I see posts like this (Eeek! I owe capital gain taxes!) fairly often on this forum.

Which makes me ask this question (really):

Has anyone on this board ever received a raise in salary and immediately stormed into the bosses'
office and screamed, " How dare you give me a raise? Now I have to pay more taxes!"

Anyone?
pjstack

User avatar
ogd
Posts: 4875
Joined: Thu Jun 14, 2012 11:43 pm

Re: Large capital gain this year

Post by ogd » Tue Mar 11, 2014 6:15 pm

henrytow wrote:ogd writes "There's not a lot we can tell about future returns of anything, except that "selling losers" is one way to badly underperform. (Why, if I keep the winners in a almost-index? I do not understand.)
Imagine that you have 50 stocks. They all have positive returns on the average, except every year 5 of them go down 20%.
It's like taking a random series of events and selecting only those that are bad for you. (Again, I do not understand. I also "select" and keep the winners.)
In the mutual fund industry, this leads to the "behavioral gap" between the funds' returns and what their performance-chasing investors are actually making. (Why?)
Henry: the answers to these questions are all related. By "random series of events" I don't mean been between stocks, but the events in the lifetime of a single stock. Normally, a stock goes up and it goes down. If you "sell the losers" and leave them sold, you've biased the outcomes against you, because you are guaranteed to participate in the downside, but not guaranteed to participate in the upside.

Consider the scenario of owning 10 stocks. Over 10 years, they all return 5% annualized, except each stock has a drop of 30% in one of those years, which means the return in the other years is something like 9.7% annualized to compensate. Your strategy is such that you sell the 30% loser for capital losses and you buy something else -- not even one of the "winners" (which would be even worse, because many are about to get spanked in this setup), but let's say you buy an index that returns a steady 5% going forward, to keep it simple.

The buy and holder of these 10 stocks, much like an index buy and holder, makes 5% annualized. For each stock, he makes 9.7% in nine of the ten years and -30% in one.

You, on the other hand, participate in some of the upside but after the drop you give up. On average, you make 9.7% for 4.5 years, -30% in another, then 5% for 4.5 years. Your return is 2.8% annualized. Your behavioral gap, without even considering the other side where you buy winners, is -2.2%.

The problem is, like I said, you took randomness and biased it against you by only taking losses. If you had sold a random stock instead, you'd have been fine. Imagine that.

The behavioral gap in the mutual fund industry has been known to run into the multiple percentage points, though it varies and it's more pronounced in some type of funds than others.

MN Finance
Posts: 1832
Joined: Sat Dec 22, 2012 10:46 am

Re: Large capital gain this year

Post by MN Finance » Tue Mar 11, 2014 6:51 pm

I'm totally shocked at the narrow vision in these negative replies. Maybe the intent of the strategy isn't clear enough, but this is absolutely a good strategy if some of the execution problems can be addressed. If 500k is designated for say VTI, deploying the same money into a basket of cap weighted individual stocks, say 50, covers probably 75 percent of the market (not sure the number, I'm on my phone) and the expected correlation to VTI is probably 95. At year end losses can be harvested and proceeds reinvested in VTI, gains could wait for 12 months then harvested and put into VTI. There are some hurdles which should be discussed to help the OP, but outright dismissal without considering the idea is absolutely myopic. My gut is that it's more trouble than its worth, but it's open to discussion. Investing in categories vs stocks in going to happen anyway and unlikely to produce the opportunity stocks will.

KyleAAA
Posts: 7751
Joined: Wed Jul 01, 2009 5:35 pm
Contact:

Re: Large capital gain this year

Post by KyleAAA » Tue Mar 11, 2014 6:57 pm

Seems like it's more trouble than it's worth unless next year happens to be a big down year but if that were the case, you'd probably be just as well in the index fund to begin with.

Easy Rhino
Posts: 3267
Joined: Sun Aug 05, 2007 11:13 am
Location: San Diego

Re: Large capital gain this year

Post by Easy Rhino » Tue Mar 11, 2014 7:04 pm

MN Finance wrote:gains could wait for 12 months then harvested and put into VTI.
I guess this is the only way it might be palatable. Because I wouldn't want to end up holding 25 or so random stocks in perpetuity just because I sold a dumb house.

rallycobra
Posts: 188
Joined: Sat Aug 23, 2008 9:40 pm

Re: Large capital gain this year

Post by rallycobra » Tue Mar 11, 2014 7:31 pm

Why don't you just purchase a multifamily rental or commercial property and do a 1031 like kind exchange? A million dollars is 25% down on a 4 million dollar property.

If you want out of real estate, It's not too late to move to a no tax state this year also. Take 6 months and a day off in Miami or Jackson Hole :) That could save you close to 100k depending on what state you are in.
26% Total Stock Market/20% Total International/13% Small Cap Value/6% Reit/35% Intermediate Bond Fund | 65/35 Stock Bond 2:1 Domestic/International + Reit

gte939h
Posts: 163
Joined: Fri Dec 20, 2013 8:39 pm
Contact:

Re: Large capital gain this year

Post by gte939h » Tue Mar 11, 2014 7:58 pm

I second the recommendation of a like-kind exchange of the property. I'm assuming this is an investment property, right?

freddie
Posts: 920
Joined: Sat Feb 08, 2014 11:06 pm

Re: Large capital gain this year

Post by freddie » Tue Mar 11, 2014 7:59 pm

The strategy is clear and effective. It is pretty much what wealthfront does by buying you 500 stocks. The problem is that it is a heck of a lot of work to do by hand. Even if you choose not to rebalance throughout the year, you will still need to be monitoring and selling constantly. And you have to make decision on when to sell and what to do after you sell. If your not willing to do that work on a regular basis, why would you do it for one year?

If I was going to do this, I think I would do it by asset class. Break the us into a dozen components, ROW and the like into 6, and then throw in things like gold and commodities, odds are one will go way up.

If you want to be sadistic this would be a great way to do a ROTH rollover. You open 500 accounts and have each buy a stock. You then recharacterize any of ROTHs that didn't go up like 75% over the next 18 months. Would you outperform the index? Nope. But you would stick the gains in a tax free world and leave the losers in the tax deferred space. Obviously filling out the tax forms and setting up that many accounts would drive you insane.
MN Finance wrote:I'm totally shocked at the narrow vision in these negative replies. Maybe the intent of the strategy isn't clear enough, but this is absolutely a good strategy if some of the execution problems can be addressed. If 500k is designated for say VTI, deploying the same money into a basket of cap weighted individual stocks, say 50, covers probably 75 percent of the market (not sure the number, I'm on my phone) and the expected correlation to VTI is probably 95. At year end losses can be harvested and proceeds reinvested in VTI, gains could wait for 12 months then harvested and put into VTI. There are some hurdles which should be discussed to help the OP, but outright dismissal without considering the idea is absolutely myopic. My gut is that it's more trouble than its worth, but it's open to discussion. Investing in categories vs stocks in going to happen anyway and unlikely to produce the opportunity stocks will.

ktwalrus
Posts: 45
Joined: Wed Mar 27, 2013 1:38 pm

Re: Large capital gain this year

Post by ktwalrus » Tue Mar 11, 2014 8:00 pm

I hate this idea. Never let taxes warp your investments. Buying a bunch of stocks (on margin yet) with the hope that some lose money so they can be sold "low" is the opposite of what your investment strategy should be. What if many of your stocks end up down 50% and none are up? It will take a long time to recover from this. Buying on margin can amplify your loses that down 90% in a year is achievable. You will be sitting there filling out your taxes next year and wonder why you lost $1 million just to avoid paying a few hundred thousand in taxes.

Take your capital gain, pay the government their share and invest the remainder in something you think will increase in value over the long run.

BTW, I made a similar mistake in March of 2000 at the height on the dot com bubble. I was aggressively trading options and had a $600K gain in one week with an options trade. I had already generated a lot of short term gains that year and didn't want to pay taxes on the $600K. So, instead of taking my profits, I exercised the options and bought a huge amount of the underlying stock. I had to margin out my account, but I figured I would just wait a year and turn my gains into long term capital gains saving me a bunch of money. Unfortunately, this left my account very heavy into high flying tech stocks. As the market declined, I got constant margin calls which I kept selling off just enough of the stocks to meet the calls. Then, in the fall, Apple (which I held a huge number of shares in and still had my account margined to the max) reported disappointing earnings and in the after hours, the stock went from $60 down to $20. Next day, the broker sold everything in my account leaving me just a few thousand left. I was lucky I didn't owe money!!! But, I had taken my account from $5M to less than $10,000 in less than 6 months.

I learned a couple valuable lessons that year. Never worry about paying taxes when making investment decisions. Paying taxes means you made money (usually). They are a sign that you "done good". The second lesson is never, ever, trade on margin. Leverage can lead to spectacular returns, but a survivable downturn can turn into a fatal mistake when you borrow money to invest in stocks and options.

Anyway, I've recovered from this mistake, but it took me 5 years and a lot of time and effort. Don't risk your $1M just to defer paying taxes. Invest the remaining after tax amount in the best way you can. If the market turns down by the end of the year, you can do some tax loss selling, but don't buy a bunch of stocks to hope that some will go down. You might end up getting what you wished for and end up turning $1M into $10,000...

Topic Author
henrytow
Posts: 11
Joined: Thu Oct 07, 2010 11:29 am

Re: Large capital gain this year

Post by henrytow » Tue Mar 11, 2014 8:34 pm

Let me repeat:
If I buy 50 stocks by taking every 10th in a cap-weighted list of the S&P 500, that list should be highly correlated with the S&P 500.
If those 50 on average go up, then the worse that can happen, compared with buying the index, after selling losers is to end up with more winners on margin than I want. That's not bad, compared with buying the index. Sell them in 2015.
If those 50 on average go down, then the worse that can happen, compared with buying the index, after selling losers is to end up with some cash. Again, that's not bad. Buy the index.

Those who argue that all the stocks might go down--well, so might the Dow, as it has only 30 stocks. A less than persuasive argument. There were others equally so.

I'll come clean: I have a Ph.D. in economics, a CFA, and used to teach CFA classes. I a m not an idiot. Idiot savant maybe.

I like the idea of picking classes of stocks, but I am not sure that every 10th stock from the top in the S&P 500 won't do the trick, of giving me my own index fund highly correlated with the S&P, but composed of,
at year's end, winners and losers, in approximate equal numbers. Harvest the losers, keep the winners.

Thanks for the comments. You helped me refine what I am going to do.

User avatar
grabiner
Advisory Board
Posts: 25648
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Large capital gain this year

Post by grabiner » Tue Mar 11, 2014 8:42 pm

If you do this, you shouldn't do it with the intention of holding cash, as it would distort your portfolio. If it happens that you buy ExxonMobil and ExxonMobil is down, you could sell it and buy Shell, keeping the same sector exposure, or wait 31 days to harvest the loss and buy ExxonMobil again. This is analogous to what many investors do with market segments when harvesting losses; you sell Small-Cap Index for a loss, and either wait 31 days to buy back Small-Cap Index, or buy a different small-cap fund.
Wiki David Grabiner

livesoft
Posts: 69587
Joined: Thu Mar 01, 2007 8:00 pm

Re: Large capital gain this year

Post by livesoft » Tue Mar 11, 2014 8:47 pm

henrytow wrote:...
at year's end, winners and losers, in approximate equal numbers. Harvest the losers, keep the winners.

Thanks for the comments. You helped me refine what I am going to do.
How do you unwind all this and save on taxes? Or maybe you don't unwind until you die?
Wiki This signature message sponsored by sscritic: Learn to fish.

ktwalrus
Posts: 45
Joined: Wed Mar 27, 2013 1:38 pm

Re: Large capital gain this year

Post by ktwalrus » Tue Mar 11, 2014 9:06 pm

henrytow wrote:Let me repeat:
If I buy 50 stocks by taking every 10th in a cap-weighted list of the S&P 500, that list should be highly correlated with the S&P 500.
If those 50 on average go up, then the worse that can happen, compared with buying the index, after selling losers is to end up with more winners on margin than I want. That's not bad, compared with buying the index. Sell them in 2015.
If those 50 on average go down, then the worse that can happen, compared with buying the index, after selling losers is to end up with some cash. Again, that's not bad. Buy the index.
The index could go down 30% this year (it has happened before). Your 50 stocks could be down 40% in such a market. Now, if you invested $2.5M (with $1.5M being on margin), you would lose (on paper) $1M. Now, I don't know how much the broker will allow the value of your 50 stocks to erode before forcing you to sell (or worse yet, before they sell them for you), but when you get a margin call, you will be forced into selling "low" (by definition).

Basically, "the worse that can happen" is that you lose your entire $1M investment.

Now, if you set aside the taxes and invest the remainder in the S&P500 and it goes down 30%, you can simply continue to keep your money in the index and, over the years, you will make the average returns of the S&P500 and the 30% down year will be long forgotten.

The worst part about your proposed strategy is the margin!!! Never borrow money to invest in equities. They are too volatile and the probability of "selling low" is significant. I can't stress this too much. I have made the margin mistake more than once and I hope I never do that again.

Also, selling the losers in a diversified portfolio has never seemed to work out for me. In the long run, these "losers" often revert to the mean and become "winners" in subsequent years. While the "winners" often become "losers" in future years, so your portfolio returns expectation using this strategy won't track the "stay the course" diversified portfolio approach.

Maybe your academic background is superior to mine, but I bet my investing experience is superior to yours and I think your strategy could lead to disaster even though, on paper, it seems logical (and almost risk free). If you really are determined to pursue this strategy, consider not doing the margin. Then you are not risking disaster, even though I think you will have less money in 10 years than if you had just paid the taxes and invested in low cost index funds with a sensible (for you) asset allocation.

jdilla1107
Posts: 804
Joined: Sun Jun 24, 2012 8:31 pm

Re: Large capital gain this year

Post by jdilla1107 » Tue Mar 11, 2014 9:13 pm

To all the people down on this strategy, this is a very common TLH strategy and all of the questions can be answered with "think of tax loss harvesting, it's the same idea."

The main issue with this is the time/effort to implement this strategy and the risk of less diversification. You are basically trying to track an index yourself, which is not that straight forward.

User avatar
ERMD
Posts: 291
Joined: Thu Dec 26, 2013 11:26 am

Re: Large capital gain this year

Post by ERMD » Tue Mar 11, 2014 9:22 pm

not to ask a dumb question, but how is this buying on margin? he's using the proceeds from selling real estate assets, free and clear. who is he borrowing from in this sceanrio?

(this sounds like a terrible idea, btw.)
between scotch and nothing, i'll take scotch. -- faulkner

ktwalrus
Posts: 45
Joined: Wed Mar 27, 2013 1:38 pm

Re: Large capital gain this year

Post by ktwalrus » Tue Mar 11, 2014 9:27 pm

jdilla1107 wrote:To all the people down on this strategy, this is a very common TLH strategy and all of the questions can be answered with "think of tax loss harvesting, it's the same idea."

The main issue with this is the time/effort to implement this strategy and the risk of less diversification. You are basically trying to track an index, which is not that straight forward.
Do you recommend the use of margin to buy $2.5M of stocks with a $1M investment?

That is the worst part of this proposal.

BTW, in 2007, my parents sold most of their real estate as they went into retirement. They had much more than $1M in capital gains. Fortunately, they paid the taxes. Then, their investment advisor (a "professional") talked them into letting him manage their nest egg. The bank was sold twice over the next 2 years (first to Wachovia and then to Wells Fargo). This "professional" had the same idea of "avoiding taxes by selling the losers". Over the 4 years they let this "professional" manage their millions, he sold low and bought high. He was very diversified (their were hundreds of stocks, bonds, and mutual funds in the account). The stocks that went up eventually all went down. This "professional" took a large fee for his professional management services each year. In the end, the account severely under performed the S&P500 and I eventually convinced my parents to let me manage their nest egg and moved the money to low cost Vanguard index funds (which have done very well and they aren't paying a "professional" to underperform).

Sometimes, the "professionals" are just too smart for their clients own good. Pursuing a "tax loss harvesting" investment strategy just doesn't seem too smart to me. You can get lucky, I suppose... and chances are you won't underperform too badly except if you are unlucky enough to be investing in a bear market...

bberris
Posts: 1333
Joined: Sun Feb 20, 2011 9:44 am

Re: Large capital gain this year

Post by bberris » Tue Mar 11, 2014 9:34 pm

DaftInvestor wrote:I'm no expert but it sounds like your philosophy is "I'd rather loose the money in the market than pay the taxes to the government".
Personally - I'd take the money - invest it correctly - and take the tax-hit.
I think you have it wrong. He wants to own a portfolio of stocks, maybe win maybe lose, but the performance will be about the same as the index. He sells all the losers to offset the gains from the real estate. Now he has unrealized gains in the winners. This allows him to defer the taxes until he sells the winners, not really avoid them.

ktwalrus
Posts: 45
Joined: Wed Mar 27, 2013 1:38 pm

Re: Large capital gain this year

Post by ktwalrus » Tue Mar 11, 2014 9:37 pm

ERMD wrote:not to ask a dumb question, but how is this buying on margin? he's using the proceeds from selling real estate assets, free and clear. who is he borrowing from in this sceanrio?

(this sounds like a terrible idea, btw.)
I might have jumped to the wrong conclusion about the margin. The OP stated:
Suppose I take the proceeds and invest in a number of stocks, say $5000 worth each of 50 stocks, approximately half on margin.
Rereading this, I see he was talking about $250,000 in 50 stocks, but I don't know why he would have "half on margin". I thought he really meant $50,000 in 50 stocks for $2.5M invested ($1.5M on margin).

Anyway, I hope I was wrong about the margin. Margin can lead to disaster...

User avatar
Ged
Posts: 3839
Joined: Mon May 13, 2013 1:48 pm
Location: Roke

Re: Large capital gain this year

Post by Ged » Tue Mar 11, 2014 9:57 pm

Let's see if I understand this.

So you sell the losers in 2014 and end up with a short term cap loss. You use this to offset income to reduce your taxes. Say the market for the year is flat. Suppose you a 7% loss on 50% of your holdings. Counteracting that you get 1.7% in non-qualified dividends on your holdings. So you end up with an overall 1.5-2% loss. That 1.5-2% loss counteracts ordinary income and reduces your taxes say 6,000. So you save 6,000 or 0.6% of your original gain. Minus trading costs of course.

Of course you still have the unrealized cap gain you could take the following year. That would counteract the loss realized the prior year.

Of course there is a risk the market as a whole will go down. If that happens you won't recover the overall loss.

I would not base an investment of $1 m. on this scheme. The potential gain is overwhelmed by the advantage of putting the $1m in a balanced portfolio.

srd178
Posts: 11
Joined: Thu Oct 03, 2013 6:25 pm

Re: Large capital gain this year

Post by srd178 » Tue Mar 11, 2014 10:04 pm

Don't let the tail wag the dog here...

livesoft
Posts: 69587
Joined: Thu Mar 01, 2007 8:00 pm

Re: Large capital gain this year

Post by livesoft » Tue Mar 11, 2014 10:05 pm

@Ged, the gain is $1MM, so the proceeds from the sale could be $2MM or more (or less). If there are capital losses of $1MM, they will offset the $1MM capital gain for a net gain of zero.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
ogd
Posts: 4875
Joined: Thu Jun 14, 2012 11:43 pm

Re: Large capital gain this year

Post by ogd » Tue Mar 11, 2014 10:08 pm

Oops, forum software played a trick on me... Removed duplicates.
Last edited by ogd on Tue Mar 11, 2014 10:11 pm, edited 3 times in total.

User avatar
Ged
Posts: 3839
Joined: Mon May 13, 2013 1:48 pm
Location: Roke

Re: Large capital gain this year

Post by Ged » Tue Mar 11, 2014 10:17 pm

livesoft wrote:@Ged, the gain is $1MM, so the proceeds from the sale could be $2MM or more (or less). If there are capital losses of $1MM, they will offset the $1MM capital gain for a net gain of zero.
Well he did say the basis was very low. :)

If you are buying and selling to offset taxes in 2014 it's not a cap loss, it's a short term loss. You would need $1M in other taxable income to take advantage of it.

herbie
Posts: 77
Joined: Mon Feb 10, 2014 6:06 pm

Re: Large capital gain this year

Post by herbie » Tue Mar 11, 2014 10:22 pm

rallycobra wrote:Why don't you just purchase a multifamily rental or commercial property and do a 1031 like kind exchange? A million dollars is 25% down on a 4 million dollar property.

If you want out of real estate, It's not too late to move to a no tax state this year also. Take 6 months and a day off in Miami or Jackson Hole :) That could save you close to 100k depending on what state you are in.
I think this was the most constructive advice provided in this thread and very worth considering.
ktwalrus wrote:BTW, I made a similar mistake in March of 2000 at the height on the dot com bubble...
Very interesting, thanks for sharing! Also reminds me of the infamous market timer thread. http://www.bogleheads.org/forum/viewtopic.php?t=5934. That OP, coincidentally, was an economics graduate student. Sound familiar, henrytow?
Last edited by herbie on Tue Mar 11, 2014 10:29 pm, edited 1 time in total.

livesoft
Posts: 69587
Joined: Thu Mar 01, 2007 8:00 pm

Re: Large capital gain this year

Post by livesoft » Tue Mar 11, 2014 10:26 pm

Ged wrote:If you are buying and selling to offset taxes in 2014 it's not a cap loss, it's a short term loss. You would need $1M in other taxable income to take advantage of it.
A short-term capital loss is still a cap loss. One would not need other [than the realized capital gain] taxable income to take advantage of it.
Wiki This signature message sponsored by sscritic: Learn to fish.

freddie
Posts: 920
Joined: Sat Feb 08, 2014 11:06 pm

Re: Large capital gain this year

Post by freddie » Tue Mar 11, 2014 10:37 pm

Well you could be in a lot lower tax bracket. If you could spread the 1 million dollar gain out over 5 years instead of 1 you could be paying 15% instead of 24%. If your in a state with a 13% top rate, there is even more of a gain to keep your average income lower.

I would be really curious to see that stats though if you bought on Jan 1 and sold just the losers in Dec what type of tax loss you could generate over a couple of different years. I guess I would be shocked if you could get more than about 200k.
livesoft wrote:
henrytow wrote:...
at year's end, winners and losers, in approximate equal numbers. Harvest the losers, keep the winners.

Thanks for the comments. You helped me refine what I am going to do.
How do you unwind all this and save on taxes? Or maybe you don't unwind until you die?

User avatar
Electron
Posts: 1934
Joined: Sat Mar 10, 2007 8:46 pm

Re: Large capital gain this year

Post by Electron » Tue Mar 11, 2014 10:41 pm

An alternative to buying a reasonably large number of domestic stocks would be to invest in all nine S&P 500 Select Sector SPDR ETFs. The nine ETFs collectively hold all the stocks in the S&P 500 index. Each ETF is itself an index fund and represents an industry group.

http://www.sectorspdr.com/sectorspdr/

SPDRs are sponsored by State Street Global Advisors.
Electron

MN Finance
Posts: 1832
Joined: Sat Dec 22, 2012 10:46 am

Re: Large capital gain this year

Post by MN Finance » Tue Mar 11, 2014 10:44 pm

I'll weigh in one more time. First, I am in no way saying that this is the "right" strategy. I expressed shock that it was dismissed on immaterial merits because it was pretty clear several replies had no idea what was happening. It's probably not a great strategy, but it's absolutely worthy of discussion if the pitfalls can be avoided. If there is more money to invest, it's clearly easier.

To the OP: There's a lot of confusion about margin and it's not really clear what's happening, but let's just make clear that if you are considering margin, any posters defending this idea are gone, I'm sure.

I'll just summarize what possibly makes sense. Let's say the long term goal is $1M in the stock market. OP decides to index that as something like:
50% Large US ETF
30% International ETF
20% Small US ETF

Instead of putting $500k in a Large US ETF he decides to buy the individual stocks. In any given year, if the market is up 10%, typically about 70% of the stocks in the S&P will be higher while 30% lower. Should the OP decide, he could take losses on the losers in a particular year to help with taxes, and defer the gains. While waiting 31 days, the money could be out of the market, in VTI, or whatever.

The OP isn't going to buy the entire S&P500 but let's say the S&P100. The correlation between SPY and OEF is .9988, so basically the same. Buying all 100 stocks is ideal, but maybe it's just the top 50. The top 25 would give you exposure to exactly half the ETF, the top 50 would give you exposure to just over 75% of the ETF, so while I don't know what the expected correlation would be, it has to be pretty close to the ETF if you use 50 (the DOW shouldnt enter the discussion).

Really to the tax front - unless you do this your whole life, there's not much benefit. If you realize $10k in losses this year but then $10k in gains next year, you just moved it around - big deal. So, buying 50 stocks and selling 15 on Dec 31 and the other 35 on Jan 1 makes sense to shift losses, but it just shifts them to next year with a lot of work and no real economic benefit. You would really have to do this forever and in that case I would want more than 50 stocks.
freddie wrote:Even if you choose not to rebalance throughout the year, you will still need to be monitoring and selling constantly. And you have to make decision on when to sell and what to do after you sell. If your not willing to do that work on a regular basis, why would you do it for one year?
So, no. This would not require any monitoring nor selling constantly. You buy 50 stocks today, then sell the "losers" Dec 31 and the "winners" Jan 1. You're replicating a cap weighted index. Probably also no need to rebalance. Most of us do it less than 1 time a year.
ktwalrus wrote:The index could go down 30% this year (it has happened before). Your 50 stocks could be down 40% in such a market.
The point is that the portfolio is extremely highly correlated to the index, so while technically it's possible to out/under perform, let's just say it's not a risk.

User avatar
pjstack
Posts: 1308
Joined: Tue Feb 20, 2007 5:03 am
Location: Harbor City, CA

Re: Large capital gain this year

Post by pjstack » Tue Mar 11, 2014 10:52 pm

henrytow wrote: I'll come clean: I have a Ph.D. in economics, a CFA, and used to teach CFA classes. I a m not an idiot.
I'm fascinated to see how all this works out. Please keep us informed.
Thank you.
pjstack

User avatar
ogd
Posts: 4875
Joined: Thu Jun 14, 2012 11:43 pm

Re: Large capital gain this year

Post by ogd » Tue Mar 11, 2014 10:55 pm

MN Finance wrote:So, no. This would not require any monitoring nor selling constantly. You buy 50 stocks today, then sell the "losers" Dec 31 and the "winners" Jan 1. You're replicating a cap weighted index. Probably also no need to rebalance. Most of us do it less than 1 time a year.
Provided he executes this one day apart, this is fine. Any longer and you're sitting on an "expensive S&P" portfolio, and who knows how that will perform. Not well, probably, given the existence of the behavioral gap and the value premium.

User avatar
ERMD
Posts: 291
Joined: Thu Dec 26, 2013 11:26 am

Re: Large capital gain this year

Post by ERMD » Wed Mar 12, 2014 6:11 am

MN Finance wrote:
ktwalrus wrote:The index could go down 30% this year (it has happened before). Your 50 stocks could be down 40% in such a market.
The point is that the portfolio is extremely highly correlated to the index, so while technically it's possible to out/under perform, let's just say it's not a risk.
underperforming may not be a risk, but correlating at ~30% sure is.
between scotch and nothing, i'll take scotch. -- faulkner

User avatar
bottlecap
Posts: 6248
Joined: Tue Mar 06, 2007 11:21 pm
Location: Tennessee

Re: Large capital gain this year

Post by bottlecap » Wed Mar 12, 2014 7:47 am

I see a little bit better what the OP wants to do now. The problem with it, aside from being complicated and subject to emotional whims, is that after the first year, you wind up with roughly half an index if you don't sell the winners, but sell the losers. Even if you buy VTI or some other fund with the losers, your risk profile has completely changed in year two, at which point you are no longer indexing. When do you sell the winners and take all that gain?

JT

User avatar
Imperabo
Posts: 1109
Joined: Fri Aug 29, 2008 1:00 am

Re: Large capital gain this year

Post by Imperabo » Wed Mar 12, 2014 9:51 am

I like the idea, and I'm also surprised at some of the knee-jerk responses. I think we've identified a bit of a blind spot--even a weakness--to indexing. Indexers give up the ability to selectively sell individual stocks for tax purposes, and that does have value.

I would consider dedicating a smaller amount, and use microcaps instead of megacaps for the following reasons:

1) It's a great way to get exposure to the micro segment, which index fund have a hard time replicating. You can roll you own index fund.
2) Micros are MUCH more volatile on individual company level, so you get more tax benefit for your investment. This allows you to allocate a smaller amount of your portfolio, and therefore the winners that you're stuck with won't unbalance your future allocation as much.

I've done this myself with great success. It doesn't take much time, and there is no emotion involved. The only problem I've found is that some of the stocks become penny stocks and cost more in transactions fees to unload.

User avatar
House Blend
Posts: 4653
Joined: Fri May 04, 2007 1:02 pm

Re: Large capital gain this year

Post by House Blend » Wed Mar 12, 2014 10:26 am

Also missing from this discussion is what long term purpose the OP has for this money. There must have been some reason for selling real estate (an investment property?), with low basis, and netting $1M in LTCG.

I generally don't want to expose myself to large amounts of LTCG without a good reason.

And if the reason is to avoid exposing my portfolio to concentrated risk in one area (RE) and move more into stocks and/or bonds, I would just do that and be done with it. And being a Boglehead, that money would go into low-cost funds, most likely index funds. Certainly I would be more aggressive than usual about harvesting losses, and I might be a bit more slicey-dicey with the funds to increase the chances of harvesting losses. That's about the extent of what I would do.

But for all we know, this is play money for the OP.

And then there's also tax planning. Depending on what other forms of income the OP will have this year, he could be on the hook for upwards of $238K in Federal taxes on these gains, plus any state taxes. Almost certainly the last dollar in LTCG is going to be taxed at 23.8%. Whether the first dollar (of the gains from this sale) will also be taxed at 23.8% depends on what else is going on, income-wise.

I don't keep large amounts of cash sitting around, maybe the OP doesn't either. That being the case, you do need to have a plan for where the cash for paying the tax bill will be coming from. If you have enough losers at the end of 2014 to use the capital from those sales to cover the tax bill the problem is solved. But if you don't, then you're faced with selling winners and either realizing short term gains (ouch), or selling other long term shares in the rest of your portfolio, or waiting until a year passes so that the winners are long term. (And there are only 13 months left before April 15, 2015.)

MN Finance
Posts: 1832
Joined: Sat Dec 22, 2012 10:46 am

Re: Large capital gain this year

Post by MN Finance » Wed Mar 12, 2014 1:26 pm

ERMD wrote:
MN Finance wrote:
ktwalrus wrote:The index could go down 30% this year (it has happened before). Your 50 stocks could be down 40% in such a market.
The point is that the portfolio is extremely highly correlated to the index, so while technically it's possible to out/under perform, let's just say it's not a risk.
underperforming may not be a risk, but correlating at ~30% sure is.
What does that mean?

MN Finance
Posts: 1832
Joined: Sat Dec 22, 2012 10:46 am

Re: Large capital gain this year

Post by MN Finance » Wed Mar 12, 2014 1:31 pm

bottlecap wrote:I see a little bit better what the OP wants to do now. The problem with it, aside from being complicated and subject to emotional whims, is that after the first year, you wind up with roughly half an index if you don't sell the winners, but sell the losers. Even if you buy VTI or some other fund with the losers, your risk profile has completely changed in year two, at which point you are no longer indexing. When do you sell the winners and take all that gain?

JT
You sell a stock and buy it back 31 days later. During the 31 days it's either out of the market, in VTI, or replaced by another similar stock. Nothing emotional about anything, just once a year tax loss harvesting. You don't ever have to sell. Just like those here who plan to hold VTI for 30 years, same with this, but it's individual stocks.

That said, It wouldnt be rocket science to do it forever, but it's not worth it for a portfolio this "small" IMO.

Post Reply