Don't cash in on your stocks just to nail down '86 tax break
New York — The stock market's turned to mush. Your broker is urging you to take your profits now before the tax law changes. And your favorite stock, Home Boobtube Buyers, is losing its oomph. Time to sell?
``The question of when to sell is the single most common concern among individuals,'' says Gerald W. Perritt, president of Investment Information Services, a Chicago-based newsletter advisory service.
Emotions often confuse the process. A particular stock may become more than a financial asset to you. It's a conversation piece. Following it has become one of your favorite pastimes. And greed may sneak in.
``Sure, it's up a lot,'' you rationalize, ``but it might double again.'' Or fear may push you toward selling: ``It's up so high, it's got to fall soon.''
The key to defusing such emotions is to make your sell decision when you buy the stock. And stick to your plan. ``The people that worry about selling typically have no preset expectations [when they buy a stock]. They just want to make money,'' Mr. Perritt notes. He likens such investors to roulette players.
But long-term investors should know enough about a company that they can set selling guidelines. For example, he says, ``When you buy a Home Shopping Network, that's when you decide `I'll sell when it reaches sales of $1 billion, or when three competitors enter the market, or when earnings growth slows below 15 percent.' When the target is met, it's time to sell.''
Other investment pros advocate setting a limit on the stock's price gain or loss -- such as 20 or 30 percent. Some follow it strictly. Others sell half of their holdings when the target is hit and wait to see if more profit can be squeezed out.
This fall the sell decision has been complicated by tax reform. Many financial planners and brokers have encouraged individuals to sell before the new tax law goes into effect. That is, take your long-term capital gains (profits on assets held longer than six months) this year, when only 20 percent (the maximum rate for those in the highest tax bracket) will go to Uncle Sam. Next year, the tax on capital gains jumps to 28 percent.
Perritt disagrees. ``Too many people who shouldn't be selling are being talked into it with that argument. They're not mentioning the interest lost or the commission fees. Unless you're thinking of selling in 1987 or 1988, don't sell because the tax law is changing.''
He advocates tallying up the costs before selling. For example:
Ms. Finwhiz invested $50,000 in common stocks back in 1982. The bull market has beefed up her portfolio to $100,000 today. She decides to sell before the tax law changes.
First, her $50,000 long-term capital gain is shaved by paying a $1,500 broker's fee (1.5 percent of $100,000). Then, the 20 percent tax on the remaining $48,500 in capital gains leaves her with a net gain of $38,000, or an $88,800 portfolio after selling.
But she's also sitting with idle assets. Finwhiz's broker will likely advise her to reinvest. Another commission fee ($1,332) is paid. Now her portfolio is worth $87,468.
In the sell-next-year scenario, the tax bite grows to 28 percent. But suppose the market goes up meanwhile. Her $100,000 portfolio grows by 10 percent. When she sells, her broker gets $1,650, the federal government takes $16,338. Her sell-next-year portfolio is worth $92,012 in cash.
Of course, to bring the sell-now portolio up to date, you have to add a 10 percent gain there. So the $87,468 swells to $96,214. The sell-now portfolio appears to be the best strategy.
But if both portfolios are brought to a cash position, paying taxes and commissions again would almost eliminate the advantage of selling early to beat the tax law changes.
In short, a sale motivated by the tax law does not result in an 8 percent saving (the difference between 20 percent and 28 percent tax). Depending on the size of the portfolio, size of the gain, commission fees, your tax bracket, and your final portfolio position, savings could shrink to 4 percent or less. Selling now may not be worth the effort.
A better motive than tax-impelled selling, investment pros say, is to sell when something better comes along. Or as the National Association of Investors Corporation puts it:``Sell because an issue of equal quality offers more gain prospects on the upside and apparently less risk on the downside.'' In fact, that's the No. 1 rule in the NIAC's Investors Manual ($12, NAIC 1515 East 11 Mile Rd., Royal Oak, MI 48067).
When considerng a sale, Perritt says, ``Ask yourself, `What will I do with the proceeds?' If you have no idea, don't sell.''
If you're still in the throes of indecision over selling, the NAIC manual suggests that you note whether key managers are leaving. Another negative would be having no growth, or sales in a crucial product sliding -- with no solid replacement in sight. If the executives of Home Boobtube Buyers are selling their stock in the company, that could also be a tip-off of bad things to come.
Insider selling is not foolproof evidence, however. Executives may sell their stock to buy a new house, put a child through college, or diversify their assets. But studies have shown that a pattern of insider selling in a small company (equity capitalizaton of $300 million or less) will, on average, indicate a stock decline.
What about mutual fund investors?
The stock market is flat or in a free fall. Is that the time to sell out? ``If you're selling mutual fund shares, you're probably engaged in market timing. That's something everyone can do but no one does right,'' Perritt quips.
He contends that professional (long-term) investors like to buy stocks when the market is going down, that's when bargains can be found. ``But when the market falls and people sell their mutual fund shares, it forces the fund manager to sell stocks to cover the redemptions. So he's selling when he should be buying.''
It should be noted that Perritt and the NAIC are biased toward the conservative, but proven, buy-and-hold school of investing.
The NAIC manual counsels: ``Don't sell just because you're tired of doing nothing. . . . Patience, based on knowledge and analysis, can be an investor's greatest asset.''
Perritt divides an investor's life into two phases: accumulation and retirement. During the first phase, one seldom sells.
``In the wealth accumulation period you want to be buying. So you want the market to be going down. The only time you really want the market to be high is at the end of your accumulation phase.'' During retirement, he says with a grin, ``you divest slowly.''