Selling: Mickey Mordech Don’t be shortchanged
The quest for quick profits could leave you shortchanged
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.