Chapter 21
Ten Things to Consider When Weighing an Investment Sale
In This Chapter
Considering your investment goals and other big-picture issues
Factoring taxes into your profit
You can and should hold good investments for years and decades. Each year, people sell trillions of dollars’ worth of investments. My experience helping folks get a handle on their investments suggests that too many people sell for the wrong reasons (while other investors hold on to investments that they should sell for far too long). In this chapter, I highlight ten important issues to consider when you contemplate selling your investments.
Remembering Preferences and Goals
If your life has changed (or you’ve inherited investments) since the last time you took a good look at your investment portfolio, you may discover that your current portfolio no longer makes sense for you. To avoid wasting time and money on investments that aren’t good for you, be sure to review your holdings at least annually. But don’t make quick decisions about selling. Instead, take your time and be sure that you understand tax consequences and other ramifications before you sell.
The time that it takes you to manage your portfolio is a vital matter if you’re starved for time or weary of managing time-consuming investments. Leo, for example, loved to research, track, and trade individual stocks — until his daughter was born. Then Leo realized how many hours his hobby was taking away from his family. This realization put his priorities into perspective. Leo now invests in time-friendly mutual funds and exchange-traded funds and doesn’t follow them like a hawk.
One of my clients, Mary, loves investing in real estate because she enjoys the challenge of researching, selecting, and managing her properties. She works in a job where she has to put up with lots of controlling, stressed-out bosses. For Mary, real estate isn’t just a profitable investment; it’s also a way of expressing herself and growing personally.
Maintaining Balance in Your Portfolio
A good reason to sell an investment is to allow yourself to better diversify your portfolio. Suppose, for example, that before reading this book, you purchased a restaurant stock every time you read about one. Now your portfolio resembles several strip malls, and restaurant stocks comprise 80 percent of your holdings. Or maybe, through your job, you’ve accumulated such a hefty chunk of stock in your employer that this stock now overwhelms the rest of your investments.
If your situation sounds anything like these, it’s time for you to diversify. Sell off some of the holdings that you have too much of and invest the proceeds in some of the solid investments that I recommend in this book. If you think your employer’s stock is going to be a superior investment, holding a big chunk is your gamble. At a minimum, review Chapter 6 to see how to evaluate a particular stock. But remember to consider the consequences if you’re wrong about your employer’s stock.
Conservative investors often keep too much of their money in bank accounts, Treasury bills, and the like. Read Chapter 3 to come up with an overall investment strategy that fits with your personal financial situation.
Deciding Which Ones Are Keepers
Often, people are tempted to sell an investment for the wrong reasons. One natural human tendency is to want to sell investments that have declined in value. Some people fear a further fall, and they don’t want to be affiliated with a loser, especially when money is involved.
Instead, step back, take some deep breaths, and examine the merits of the investment you’re considering selling. If an investment is otherwise still sound, why bail out when prices are down and a sale is going on? What are you going to do with the money? If anything, you should be contemplating buying more of such an investment. Also, don’t make a decision to sell based on your current emotional response, especially to recent news events. If bad news has recently hit, it’s already old news. Don’t base your investment holdings on such transitory events. Use the criteria in this book for finding good investments to evaluate the worthiness of your current holdings. If an investment is fundamentally sound, don’t sell it.
A better reason to sell an investment is that it comes with high fees relative to comparable investments. For example, if you own a bond fund that is socking you with high fees, check out Chapter 8 to discover high-performing, lower-cost funds.
Tuning In to the Tax Consequences
When you sell investments that you hold outside a tax-sheltered retirement account, such as in an IRA or a 401(k), taxes should be one factor in your decision. (See Chapter 3 to find out about tax rates that apply to the sale of an investment as well as to the distributions that investments make.) If the investments are inside retirement accounts, taxes aren’t an issue, because the accounts are sheltered from taxation until you withdraw funds from them.
Just because you pay tax on a profit from selling a non-retirement account investment doesn’t mean you should avoid selling. With real estate that you buy directly, as opposed to publicly held securities like REITs, you can often avoid paying taxes on the profit that you make (see Chapters 10 and 11 for details).
With stocks and mutual funds, you can specify which shares you want to sell. This option makes selling decisions more complicated, but you may want to consider specifying what shares you’re selling because you may be able to save taxes. (Read the next section for more information on this option.) If you sell all your shares of a particular security that you own, you don’t need to concern yourself with specifying which shares you’re selling.
Figuring Out What Shares Cost
When you sell a portion of the shares of a security (for example, stock, bond, or mutual fund) that you own, specifying which shares you’re selling may benefit you taxwise. Here’s an example to show you why you may want to specify selling certain shares — especially those shares that cost you more to buy — so you can save on your taxes.
Suppose you own a total of 300 shares of a stock and you want to sell 100 shares to pay for a root canal. Suppose further that you bought 100 of these shares a long time ago at $10 per share, 100 shares two years ago at $16 per share, and the last 100 shares one year ago at $14 per share. Today the stock is at $20 per share.
The IRS allows you to choose which shares you want to sell. Electing to sell the 100 shares that you purchased at the highest price — those you bought for $16 per share two years ago — saves you in taxes. To comply with the tax laws, you must identify the shares that you want the broker to sell by the original date of purchase and/or the cost when you sell the shares. The brokerage firm through which you sell the stock should include this information on the confirmation slip that you receive for the sale.
The other method of accounting for which shares are sold is the method that the IRS forces you to use if you don’t specify before the sale which shares you want to sell — the first-in-first-out (FIFO) method. FIFO means that the first shares that you sell are simply the first shares that you bought. Not surprisingly, because most stocks appreciate over time, the FIFO method usually leads to you paying more tax sooner. The FIFO accounting procedure leads to the conclusion that the 100 shares you sell are the 100 that you bought long, long ago at $10 per share. Thus, you owe a larger amount of taxes than if you sold the higher-cost shares under the specification method.
Although you save taxes today if you specify selling the shares that you bought more recently at a higher price, remember that when you finally sell the other shares, you’ll then owe taxes on the larger profit. The longer you expect to hold these other shares, the greater the value you’ll likely derive from postponing, realizing the larger gains and paying more in taxes. If you expect your tax rate to decline in the future, you have another good reason to hold off selling the shares in which you have greater profit.
When you sell shares in a mutual fund, the IRS has yet another accounting method, known as the average cost method, for figuring your taxable profit or loss when you sell a portion of your holdings in a mutual fund. This method comes in handy if you bought shares in chunks over time or reinvested the fund payouts into purchasing more shares of the fund. As the name suggests, the average cost method allows you to take an average cost for all the shares you bought over time.
Selling Investments with Hefty Profits
Of course, no one likes to pay taxes, but if an investment you own has appreciated in value, someday you’ll have to pay taxes on it when you sell — unless, of course, you plan to pass the investment to your heirs upon your death. The IRS wipes out the capital gains tax on appreciated assets at your death. Capital gains tax applies when you sell an investment at a higher price than you paid for it (see Chapter 3).
Odds are, the longer you’ve held securities such as stocks, the greater the capital gains you’ll have, because stocks tend to appreciate over time. If all your assets have appreciated significantly, you may resist selling to avoid taxes. However, if you need money for a major purchase, sell what you need and pay the tax. Even if you have to pay state as well as federal taxes totaling some 35 percent of the profit, you’ll have lots left. (For “longer-term” profits from investments held more than one year, your federal and state capital gains taxes would probably total less than 25 percent.)
Before you sell, do some rough figuring to make sure you’ll have enough money left to accomplish what you want. If you seek to sell one investment and reinvest in another, you’ll owe tax on the profit unless you’re selling and rebuying real estate (see Chapters 10 and 11).
If you hold a number of assets, in order to diversify and meet your other financial goals, give preference to selling your largest holdings with the smallest capital gains. If you have some securities that have profits and some that have losses, you can sell some of each to offset the profits with the losses.
Cutting Your (Securities) Losses
Perhaps you have some losers in your portfolio. If you need to raise cash for some particular reason, you may consider selling select securities at a loss. You can use losses to offset gains as long as you hold both offsetting securities for more than one year (long term) or you hold both for no more than one year (short term). The IRS makes this delineation because the IRS taxes long-term gains and losses on a different rate schedule than short-term gains and losses (see Chapter 3).
If you need to sell securities at a loss, be advised that you can’t claim more than $3,000 in net losses in any one year. If you sell securities with net losses totaling more than $3,000 in a year, you must carry the losses over to future tax years. This situation not only creates more tax paperwork but also delays realizing the value of deducting a tax loss. So try not to have net losses (losses + gains) that exceed $3,000 in a year.
Some tax advisors advocate doing year-end tax-loss selling with stocks, bonds, and mutual funds. The logic goes that if you hold a security at a loss, you should sell it, take the tax write-off, and then buy it (or something similar) back.
When selling investments for tax-loss purposes, be careful of the so-called wash sale rules. The IRS doesn’t allow the deduction of a loss for a security sale if you buy that same security back within 30 days. As long as you wait 31 or more days, you won’t encounter any problems. If you’re selling a mutual fund or exchange-traded fund, you can purchase a fund similar to the one you’re selling to easily sidestep this rule.
Dealing with Unknown Costs
Sometimes you may not know what an investment originally cost you. Or you may have received some investments from another person, and you’re not sure what he or she paid for them. If you don’t have the original statement, start by calling the firm where the investment was purchased. Whether it’s a brokerage firm or a mutual fund company, the company should be able to send you copies of old account statements, although you may have to pay a small fee for this service.
Also, increasing numbers of investment firms, especially mutual fund companies, can tell you upon the sale of an investment what its original cost was. The cost calculated is usually the average cost for the shares you purchased.
Recognizing Broker Differences
If you’re selling securities such as stocks and bonds, you need to know that some brokers charge more — in some cases, lots more — to sell. Luckily, even if the securities that you want to sell currently reside at a high-cost brokerage firm, you can transfer them to a discount brokerage firm. Head to Chapter 9 to read about the different types of brokerage firms and how to select the best one for your situation.
Finding a Trustworthy Financial Advisor
If you delegate your investment decision-making to an advisor, you may be disappointed in your returns. Few financial advisors offer objective and knowledgeable advice. Unfortunately, if you’re grappling with a selling decision, finding a competent and impartial financial advisor to help with the decision is about as difficult as finding a politician who doesn’t accept special-interest money. Most financial consultants work on commission, and the promise of that commission can cloud their judgment. Among the minority of fee-based advisors, almost all manage money, which creates other conflicts of interest. The more money you give them to invest and manage, the more money these advisors make.
If you need advice about whether to sell some investments, turn to a tax or financial advisor who works on an hourly basis.