Year-End Portfolio Prep

In mid-December, I generally take a little time with my portfolio to prepare for the year's end and line myself up for success next year. There are three primary areas I focus on: harvesting losses, rebalancing, and giving. Let’s have a look at each.

Harvesting gold from losses

Every year, there are stocks in my portfolio which went the wrong way and are now below my purchase price, dragging down my returns and putting red on my statements. It’s normal, it happens every year, and you should expect it of at least say, 30% of your stock picks. But there is one thing you can do to make lemonade from the lemons: you can harvest the loss on your taxes.

All that means is selling the negative position. You’ve then “realized” the loss—remember, stock moves are not taxable events until you sell them for a loss or a gain; all your returns are virtual until you sell. That loss will show up on your tax returns and will offset gains you’ve made elsewhere, both from assets sold for a profit and from regular income. So let’s say you have a stock which you bought for $1,000 which is only worth $600. If you sell by the end of the year, you’ll get $600 (minus trading costs), and the $400 you lost on that investment can be subtracted from your taxable income for that year, which reduces your overall tax bill. There’s no downside, and no catch.

There are, however, two limitations to careful of. The first is that you are restricted to a total of $3,000 in losses against your tax bill. Anything you sell beyond that amount of loss will be disallowed from offsetting your gains (but you can see your CPA about forwarding the loss in later years). The second is called the “wash-sale rule.” Basically, if you sell an asset for a loss and then repurchase the same asset or a nearly identical asset within 30 days, the IRS will disallow the loss. So make sure that, if you harvest a loss on a stock you like and intend to repurchase, you wait a month first. Details on tax loss harvesting can be found here and here.

Another useful annual ritual (I actually do this continually through the year) is a rebalancing of the assets you hold to realign your portfolio with your goals and risk tolerance going forward. The idea is to buy or sell equities specifically to reestablish the asset balance you intended to hold (stocks to bonds to gold, or technology to banking to pharmaceuticals). So if during the year you cashed in or sold a few bonds, and you are now theoretically underweighted in bonds, you would buy some to balance the scales. Or if one tech stock in particular rose dramatically this year (AMZN, NFLX), hypothetically you now hold more technology than you intended (and you have categorically more risk from having so much tied up with just one stock). So you would sell some off, or buy another asset to offset the tech you hold. If you’re not a regular buyer (and if you're reading this I hope you’re not a regular trader), and in fact you don’t look at the portfolio terribly often, rebalancing is good practice to ensure proper a comfortable and adequate allocation in your basket of assets. It will also help you to sleep better. Two great articles and some depth about rebalancing can be found here and here. 

Finally, I like to spend some time with my family choosing and giving to charities at the close of each year. When most people give to a non-profit, for the sake of simplicity they write a check or just put the gift amount on a credit card online. But did you know that many non-profits, particularly larger ones with more developed infrastructure and staff, accept gifts of stock directly? 

If you sell a stock during the year which has risen since your purchase, you’ll pay gains taxes on the sale. You can then use the proceeds from that sale to buy another stock, to pay for a trip or your children’s tuition or just to go shopping. If you use those proceeds for charitable giving, you’ve just paid capital gains tax on money you intend to give away, making your gift that much more expensive. You can still write off the dollar value of the charitable gift itself, but only that amount.

charity: water

If instead you give a non-profit an appreciated stock directly, you’ll pay no gains tax (you didn’t sell it, so you never realized the gain) and you can deduct the entire value of that stock from your taxable income. In other words, depending on your gains tax rate, most of us would save 15% right there. The charity gets a larger total amount, albeit in the form of a stock. And they can choose to hold those stock shares for future gains, or sell it themselves and pay no taxes. (For more on 2015 capital gains tax rates, look at this.)

So take a few minutes this weekend to look things over and make sure your assets are where you want them to be before the tax year closes. A little minor tinkering can save money and headaches later, and put you on the right road going into the new year.

Drifting to Fifty | Random unrelated nugget of the week

Don't fret over those sloppy holiday party guests: Mayonnaise spread thick on a wooden table over a condensation ring will absorb the moisture, clearing the ring. But it will happen slowly. 

Don't just do something! Stand there!!

In the summertime when I was a kid my mom would come into the family room and kick me off the TV. “Go outside. Go do something.” When we’re in school we’re told to work hard, get involved, do our homework, be productive. As adults at work we know we have to perform: tackle assignments, manage the team, track all tasks, host the meeting, complete the project, exceed expectations. At the gym. Around the house. In our communities. Constantly, everywhere, it’s all doing. We are never, never, never supposed to just sit there and do nothing.

Which means it’s all terrible training for investing. No wonder most people fail.

A huge percentage of investors—both hobbyist individuals and professional managers—suffer from action bias, which is the need for action over inaction. This is hardly a surprise given what we’re taught in every other aspect of our lives. So they’ll sell a stock when it falls, afraid it will never return or certain they can move the money to something which will only go up. Or they fear a company of which they own shares is overpriced, so they dump it. Or the nation is going to war, or the Federal Reserve is raising interest rates, or they read the future will be in gold, or real estate, or some financial TV loudmouth who is paid to make hyperbolic alarmist calls says to get out. So they sell everything. Which is the worst thing they can do: the stock market always rises—if we wait long enough.

Life is terrible training for investing. 
No wonder most people fail.

Just sitting there and watching your investments go up and down is really difficult.  We think we can do better. We think we can make our money grow faster. We heard a great stock tip, or a new investing concept, or a buddy is building an app and we can be millionaires. We want to do something to decrease our losses or increase our returns or at least protect ourselves from the crazy nauseating roller coaster ride.

But that’s just it. We have to wait. If we try to speed things up we will make mistakes, we will misjudge and risk and over-leverage. Warren Buffet has said “The stock market is a device for transferring money from the impatient to the patient.” He’s right, of course; he’s been investing for over 60 years. If we get impatient, we act. That’s how we’re built, how we’ve trained since birth: doing better means doing more. Which is false when it comes to investing.

To be clear, there is work to be done. But the lion’s share is at the start of the investment, when we are researching and tracking performance and trying to project forward to determine forthcoming success. We monitor not only the company under consideration but the market operates in, the competition it faces, the trends and buying habits of customers stretching into the future.

But once we pull the trigger and buy ownership in that business, we have to sit on our hands. We still keep up, of course: news reports, press releases, earnings and so on. But that’s it, the decision to become owners was already made. Now, we sit there and let the money we invested work for us. It’s not the same as school, or our work. It’s passive.

As my regular readers know, there are only 4 reasons to sell a stock:

1. The value of one company’s stock has grown so much that your portfolio needs to be rebalanced to reduce single-stock risk: I’ve sold off Apple shares close to a dozen times since 1997 in order to reduce the percentage of my portfolio in that one company.
2. The company you own did something that changes the thesis for ownership in the first place: 3D Systems (DDD) massively overestimated the consumer market for 3D printers, and sales have been shockingly bad; Research in Motion (Blackberry, BBRY) completely missed the transition from keyboards to touchscreen technology, and gave up over 60% of its customers in three years (click here).
3. One stock in your portfolio has been bouncing around below your purchase price for awhile, and you decide to sell for a loss in order to offset gains elsewhere in your tax return.
4. You’d rather have the money. 

Day-to-day price gyration—of the company or of the broader market—is not among the reasons. If you sell because you can’t stand watching a good company’s price drop, planning to reallocate the money elsewhere or, worse, to go shopping, you will miss on the gains to come later.

By way of example: I currently one stock in particularly bad shape: I bought GoPro (GPRO) in late July, and it’s down 60%. 

“The stock market is a device for transferring money from the 

impatient to the patient.” – Warren Buffett

Down 60%! you say. Why haven’t you given up on it!? I haven’t sold because, regardless of the market price of the stock, GoPro is an excellent company with something like 80% market share f or small cameras and years of solid profitability. It’s got smart managers and no debt and a great brand. It’s going gangbusters, share price be damned. If the company continues to grow and make money, the shares will come back. I might buy more. Isn’t that be the kind of business you want to own? 

The solution is just about never to jump in and take action. It’s to distract yourself however you can and sit tight. I know some individuals who only check on their holdings weekly, or monthly. I have one friend who only looks at his portfolio when the market is closed, preventing her from a knee-jerk sell order she would later regret. Whatever works for you: constant churn of a stock portfolio will destroy your returns over time. Better plan: go watch the game, learn a new recipe, play with your kids. The future will arrive soon enough.