Taxes Coming? Take a Deep Breath and Do Nothing for Now
It seems all but inevitable taxes will go up. Of course, at this moment the particulars of any new taxes are not known. They can only be imagined.
Despite this, there's been a lot of news and punditry about what investors should do. Two popular pieces of advice are: 1) take your gains now because your capital gains taxes will be higher in the future and 2) sell your dividend stocks now because higher new tax rates on dividends are going to put significant downward pressure on these stocks.
My advice is: Take a deep breath and don't do a thing. At least for now. I feel investors will be better served to think through the myriad of options and possibilities with respect to taxes and investments.
First, I want to provide one overall principle to guide your thinking: Taxes should never drive investment decisions, they should only influence them. This nugget gives entry to what the other possibilities are.
With respect to selling stock now to take the capital gains hit at what many expect will be a lower capital gains tax rate, the first point to consider is whether or not it's a good investment. I've held some stocks for more than 20 years, which means they saw the Bush tax cuts coming, and presumably, going. If it's a growth stock without much in the way of dividends, the principal you end up with in five or 10 years could far outweigh a tax differential.
What may make more sense than selling your winners is to sell your losers instead. Remember, if tax rates are going up, the value of your loss carry-forward is going up, too. If you take a loss now, you can throw it against gains that you might take in 2013 and 2014.
Remember, if you take a $10,000 loss you realized and did not use in 2012 and throw it against a $10,000 gain that you realize in 2013 or 2014, whether or not taxes rose is somewhat moot with respect to those two investments.
Further, I feel that pruning your losing investments is oftentimes a more productive exercise than trimming your winners. Why? Because investors tend to hold onto losers longer than they should, many times for emotional reasons, and realize even larger losses when all is said and done.
Getting rid of losers takes more discipline than selling winners, and the occasion of higher taxes may be the motivation needed to do what you should already be doing.