Sell­ing: Mickey Mordech Don’t be short­changed

The quest for quick prof­its could leave you short­changed

Money Magazine Australia - - CONTENTS - STORY MICKEY MORDECH

The buy de­ci­sion gets all the at­ten­tion in in­vest­ing. Peo­ple are al­ways hunt­ing for the next big thing and shar­ing ideas. Equally im­por­tant is the ques­tion of when to sell. When do you call it quits and aban­don an in­vest­ment that hasn’t worked out? And when do you take prof­its on your win­ners?

The sell de­ci­sion is com­pli­cated by the thorny is­sue of cap­i­tal gains tax which, it turns out, can have a huge im­pact on your over­all port­fo­lio re­turns. You’ll make a cap­i­tal gain or loss when you sell shares – pro­vided it’s not at the same price you paid (and as­sum­ing those shares were bought on or af­ter Septem­ber 20, 1985). Where you’ve held a stock for over a year, in­di­vid­u­als can halve the gain, while com­ply­ing self-man­aged su­per funds can knock off 33%.

In any par­tic­u­lar tax year, you tally up your re­alised gains and losses (in­clud­ing any losses you’ve car­ried for­ward from prior years) for your net cap­i­tal gain (or loss) for the year. You then add this to your as­sess­able in­come, and it gets taxed along with your other in­come. So when you sell a stock and make a gain, you’ll have less to rein­vest in an­other op­por­tu­nity due to the tax you’ll have to pay.

The key point here is that if you choose not to sell, and thereby avoid pay­ing the tax, you’ll get to keep us­ing that money – and mak­ing re­turns on it – un­til you do. In ef­fect, the ATO is pro­vid­ing you with an in­ter­est-free loan of the cap­i­tal gains tax payable – right up to the point that you make the sale and crys­tallise the gain.

The implication is clear: the shorter your in­vest­ing time hori­zon and the more fre­quently you turn over your stock port­fo­lio, the less money you’ll have earn­ing re­turns for you. We can see how it might work with an ex­am­ple.

Let’s say that five years ago you – an in­di­vid­ual with a mar­ginal tax rate of 37% – fol­lowed our rec­om­men­da­tion to buy CSL, in­vest­ing $10,000 to buy 308 shares. Six years later, the hold­ing has swelled to $64,880 and you’re con­sid­er­ing tak­ing the profit and mov­ing on.

If you stay put, you’ll keep that $64,880 in­vested, earn­ing re­turns and pay­ing div­i­dends. But if you sell, you’ll need to pay $10,153 in tax (the gain of $64,880, halved since you’ve held it for more than a year, times your 37% tax rate). That means you’ll only have $54,727 to in­vest in its re­place­ment. It doesn’t sound like much but these dif­fer­ences re­ally add up over time. Let’s look at an­other ex­am­ple.

Say you’re in­vest­ing as an in­di­vid­ual, ca­pa­ble of earn­ing re­turns of 10% a year be­fore tax and you’re start­ing with a port­fo­lio worth $100,000. Again, your tax rate is 37%, and you’re con­sid­er­ing three pos­si­ble in­vest­ment strate­gies.

1. Buy and hold.

2. Buy and hold for five years, at which point you cy­cle into new in­vest­ments.

3. Buy and hold for one year, at which point you cy­cle into new in­vest­ments.

Over the next 15 years, the chart shows what your re­turns would look like for each strat­egy.

In the first few years there’s lit­tle dif­fer­ence. Over time, though, the tax pay­ments re­ally start to eat into your re­turns. It’s like com­pound in­ter­est in re­verse: each dol­lar you pay to­wards CGT is a dol­lar that isn’t earn­ing re­turns for you in the fu­ture. The more you trade, the worse it gets, and that’s in ad­di­tion to all the trad­ing costs. Of course, there will be times when it makes sense to sell – when you find a bet­ter op­por­tu­nity (even af­ter pay­ing any tax), when a stock has grown to have too large a weight­ing in your port­fo­lio, or when an in­vest­ment case isn’t work­ing out. If any of these ap­ply, don’t waste a mo­ment wor­ry­ing about tax.

In­vest­ing works best, how­ever, when you buy and hold a bunch of stocks ca­pa­ble of com­pound­ing your cap­i­tal at high rates of re­turn for long pe­ri­ods of time. Un­for­tu­nately, great busi­nesses, with long-last­ing com­pet­i­tive ad­van­tages and op­por­tu­ni­ties to rein­vest at high rates of re­turn, are few and far be­tween. That means you need to have the pa­tience to ac­quire them at the right price – and then hang onto them if you can. Com­pa­nies like these tend to trade on high mul­ti­ples, so there’s al­ways a temp­ta­tion to take prof­its. But if you sell them, not only will it be hard to find some­thing of sim­i­lar qual­ity to re­place them, you’ll also have less money work­ing for you.

Mickey Mordech is an an­a­lyst at In­tel­li­gent In­vestor,partoftheIn­vestSMARTGroup.Toun­lock more stock re­search and buy rec­om­men­da­tions, regis­ter for a free trial at in­vestsmart.com.au/ money. This ar­ti­cle con­tains gen­eral in­vest­ment ad­vice only un­der AFSL 226435.

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