With 2014 drawing to a close, that time-honored tradition of harvesting losses to offset gains is upon us yet again. However, this year offers a new twist: losses are hard to find amid broadly positive financial market conditions. Even mutual fund managers will find it difficult to avoid reporting capital gains distributions this year. As such, investors may want to take a different approach. Instead of fearing capital gains, embrace them. After all, they’re gains!
People Dislike Paying Taxes
According to Gallup, a majority of Americans consistently think they pay more than their fair share in taxes. And a recent study indicates that if given the choice between purchasing a product nearby at a discount versus having to travel some distance for an equivalent sales tax holiday, considerably more people would take the trip to avoid having to pay the tax.
The same attitude about taxes persists in the world of investments. Every year, taxable portfolios are assessed to find losses to offset capital gains. But what happens if our resistance to paying taxes leads to suboptimal outcomes? Investors often cite capital gains as a reason to not sell an investment that has done well because doing so would raise their tax obligation. This reluctance to sell is true even if the investment is expensive. Conversely, taking capital losses on investments that have done poorly to offset a gain might mean selling an investment just when it has become cheap.
Clearly, investors dislike paying taxes so much that they will take losses to offset gains (or not sell to avoid paying taxes) regardless of valuation considerations. This seems somewhat irrational. Have you ever known someone to turn down a promotion because it put them in a higher tax bracket? Obviously not. Similarly, if you’re disappointed that your portfolio is doing well simply because of capital gains liability, then something is a bit off. Gains should be celebrated, not loathed.
Time to Rebalance
To aid in the celebration, here are a few investment ideas that may go against the grain from a tax perspective but that could enhance future performance and minimize risks in your portfolio.