It’s Tax Time – Tax Loss Selling
We are into June, and it’s time for financial advisers and accountants to start talking to clients about tax loss selling in stocks, something that we should probably all think about in May rather than June, but whatever. It works like this.
Assuming you pay Capital Gains Tax, many of you don't, on June 30th the tax man will freeze your portfolio, add up all the capital gains and losses you've made this year (gains and losses you have actually crystallised by selling stocks), offset the losses against the gains and come after you for CGT on any residual net profit.
If your accountant hasn't reminded you then this is your reminder that you can minimise ("defer") your capital gains tax liability this year (any year) by realising some of your unrealised losses before the year-end, by taking losses that are on paper only at this point – because you haven’t sold yet.
At this time of year, you should be looking through your year of trading, working our if you are up for CGT, and if you are, combing your collection of current holdings for any stocks with losses attached that you could sell before the tax year end to crystallise a loss that can be used to offset the gains (if any) you are about to be taxed on. In so doing you can minimise your need to pay the tax this year.
Ultimately it is not about how much tax you pay, that will not change; it is about when you pay it. You want to pay it later. It is obvious stuff.
But of more interest to investors than your personal tax situation, and what you may not know, it that this process of tax loss selling impacts on share prices. In particular:
- Stocks that have not performed well over the year, stocks in which a lot of shareholders are holding at a loss coming into the financial year end, tend to get sold down again towards the end of June. Thanks to tax loss selling, bad performers perform badly in June.
- Small illiquid stocks can get massacred by tax loss selling in June because the selling is forced through when the liquidity is not there. Net result, if you hold an illiquid stock now that is running at a loss, and a lot of other shareholders have losses, take the loss early, because if you wait until the end of June when every other dodo wakes up to it, you'll be selling into a last-minute selling frenzy.
- Taking advantage of the selling – Tax aside the ‘game’ you could play here is as a trader buying the stocks that get pummeled running into the last week of June. Stocks that are trading favourites that have fallen from grace always have a lot of stale holders. They can get killed again in June and often resurrect in July. There may be a trade in there, capitalising on other people's laziness (leaving their tax loss selling to the last moment) and mistakes (buying small illiquid stocks that fell over).
- If you do want to take a loss before the end of June, but want to continue holding the stock long term, it may still be a good idea to take the loss, early, now for instance, and not buy it back immediately but wait until the other tax loss sellers destroy it. If all goes well, you can buy it back lower down as the liquidity issue bites the share price closer to the financial year-end.
- Even if you don’t have tax issues, thanks to tax loss selling, trading opportunities can arise, especially in the small illiquid stocks that get massacred. Once the tax loss selling fades away sold down stocks can bounce significantly as small buy orders rebound the prices. Traders go looking for the lows in small illiquid sell-offs over June hoping for a rally into July. But another word to the wise, while you might think you should wait until July 1 to buy, experience suggests that a lot of the stocks impacted by tax loss selling tend to bounce before the year-end, a week or so before the year-end. So for a trader, the game is to identify the stocks that are getting destroyed now and watch for the first rally, rather than the 1st of July, to buy back in. The rebounds can be just as sharp as the last-minute drops, hesitate, and you'll miss it.
Which stocks do you sell for tax reasons? I could list the worst performer in the last year, but it’s a bit irrelevant. The stocks that you should target are the stocks in your own portfolio. I don't know what they are, you do, and anyway, you may not have a capital gains tax issue. But if you do, it’ll be pretty clear which stocks you can sell; it’s the stocks are you holding at a paper loss. The smaller and more illiquid they are, the earlier you need to sell them and, if you still want to continue to hold the stock long term, the closer to June 30th you buy it back the cheaper you should get it.
For what its worth here are some of the worst performing stocks in the ASX 300 over the last year – but its not reaslly about them, its about what stocks you hold. But for traders this is a list to watch this month, some of these stocks, especially the illiquid ones, are likely to get flogged into the year end offering a trading opportunity, if only for a couple of weerks, to catch the relief rally rebound in late June early July.
Ugly smaller stocks:
ARE YOU BAD AT SELLING?
Selling for some of you (you amateurs!) is difficult. A lot of you never sell, even at a loss. For a lot of you those short-term trades that became long-term ‘investments’, all those holdings worth $100 that used to be worth $10,000, are ‘not worth selling’. But they are if they have a $9,900 capital loss attached and you have capital gains this year. There is a point selling. They too have value now.
But if that's still not enough, to help you with your weak-brained inability to sell, I have developed these now familiar (to some of you) arguments to persuade you. If you are having trouble taking a loss, are not enjoying your trading, are getting emotional and the stock is still in your possession…read my reasons for why you should think about letting go of the dogs. You will have put the sell order on before you get to the end:
- If a stock is going down, it is far more likely to continue going down than it is to turn on a sixpence to suit you.
- An early loss is the smallest loss – The further a stock falls, the more intense the selling becomes as higher losses cause more selling decisions, so sell early.
- The odds are in your favour – If you sell ten falling stocks, it will be the right thing to do in nine cases, but you will only remember the other one.
- Clear the mind – If you sell now, you are no longer exposed, and all you have to do is come to terms with the loss.
- You can buy it back – If you sell now you can always buy it back – you might even buy it back lower than you sold it and in the meantime, you have a period of clarity.
- The eye of the hurricane – If you sell now, you enter the eye of the storm, and all becomes calm. You have a moment to think, and you can watch from a distance. You can always choose to enter the storm again, and you will be thinking more clearly and be armed with a plan if you do.
- Would you buy this stock now? – If you are making a loss on a stock, think to yourself … “If I had cash, would I buy this stock now at this price?” If the answer is ‘No’, then why are you holding it? Sell it. Most people begin to ‘hate’ the stocks they lose money in … so this argument always works.
- Your state of mind has a value – What would your spouse pay (or you pay) to have you carefree at the weekend instead of ripping the heads off the kids. Look after yourself. There are not that many weekends in the year or your life. Don’t ruin too many of them by keeping risky loss-making positions until Monday because you didn’t have the guts to sell them on Friday.
- Averaging down is a mug’s game – If you have money to invest, you should be putting it in the best investment in the whole world. Do you really think that will be the very same stock you have already bought at a higher price, and that is falling at the moment? Very unlikely. You already have an exposure … why do you need more of something that has already proved itself to be a dog?
- There is no logic in being emotional about losses – Do what most brokers do with their own shareholdings. They have an Excel spreadsheet linked to live prices monitoring all their holdings and what they are worth. At the bottom of the page is a total of what all the holdings are worth now. That clicks over every second all day. Up $500 down $500. This figure is the only truth. This is what the shares are worth.
- The price you paid is irrelevant – If it’s gone down, it’s gone down. XYZ stock doesn't "owe you"…what you paid for it is irrelevant to where it goes next.
- Opportunity cost – Not selling a dog ties up capital that could be employed somewhere more gainfully than in a dog stock.
- If in doubt, get out, sell it – It crystallises a capital loss for this tax year. Why wait until the end of the year to take your losses? Taking losses today could set you up for making and taking gains this year. You can always buy it back once you’ve made the sale.
Hopefully, you hold good long term stocks and won’t have to take a loss.
And if you are having trouble sleeping this is the ATO's brochure "Personal Investor's Guide to capital gains tax 2016
(Legal note: ATO wash-sales provisions – If you do decide to take a loss before 30 June but plan to re-adopt one or more of your dogs in the new financial year, be mindful of the ATO’s position on wash-sales. If you repurchase the shares you sold very shortly after at a similar price, the ATO will look at that transaction unfavourably and you may be subject to anti-avoidance rules.)