Strategy, firm decision-making and flexibility can help investors reverse unrealised losses in their share portfolios, according to finance experts that TheBull spoke to.
The first step is to examine your share portfolio and separate the gains from the losses.
So if you are currently nursing losses on a stock that you believe has strong fundamentals and good prospects, what should you do – sell, hold on or buy more?
Let’s say that you’re holding 1000 shares in a stock and the $40 you originally paid for each share has fallen by 50 per cent. Right now, if you believe the stock is cheap, then holding the original parcel while buying more shares could prove a shrewd and rewarding move over time.
If you buy another 1000 shares today at $20 and the price climbs to $30, then this stock in your portfolio is no longer sitting on a loss, but is price neutral. If the share price climbs to $35, then your total stock holding is sitting on paper gains and selling the shares will realise a profit. This strategy of dollar cost averaging works when you buy more of a losing stock in your portfolio and that stock recovers.
Finance planner Neil Cox says the market meltdown is providing numerous dollar cost averaging opportunities. “I draw a circle around a company’s share price dips and buy the stock if I believe it’s cheap on due diligence,” says Cox, a director of Financial Foundations Australia. Cox says dollar cost averaging could be the right strategy for buying CSL, Woolworths, BHP Billiton, AGL, Origin Energy and Wesfarmers in a sharemarket that appears to be at its cheapest level in 40 years based on fundamental measures. Cox says investors can also get share discounts through rights issues and dividend reinvestment plans. But he warns the market may fall further, but, equally, could quickly recover “in its first phase” on signs of an improving global economy.
Depending on your outlook, you can guard against further price falls by simply selling an under-performing stock and crystallising a loss. Some might agree with Cox, who says the selling disciplines of too many investors, particularly novices, is poor. “We can often make the mistake of marrying our stocks, nurturing them,” Cox says. A stock isn’t necessarily cheap, or offers top value just because the price is 50 per cent or more off its highs. The share price may fall a lot further depending on a myriad of factors, including too much debt.
Crystallising a loss can be a positive move. Firstly, the sale proceeds can be used to buy other better performing stocks with a brighter outlook. And, in this market, analysts say there are plenty of bargains. Also, buying a stock that rises can recover losses realised in the poor performer you sold. Secondly, crystallising a loss can reduce an investor’s capital gains tax liability on stocks sold for a profit. Losses can offset capital gains, but losses can’t be deducted from income.
Chartered accountant Laurie Hellier says capital gains tax on profits applies at the individual’s marginal rate. Hellier, also a finance planner, says crystallised losses, in the absence of capital gains in the current financial year, can be carried forward indefinitely and offset against future capital gains. Investors who made profits on selling shares, or other assets since July 1, 2008, may be liable for capital gains tax this financial year.
Hellier points out that the capital gains tax regime is flexible, enabling investors to use asset losses to legitimately minimise tax. Hellier says losses in one asset class can be offset against gains in another. Investors who crystallise share market losses between July 1 last year and June 30 this year can offset them against capital gains made on selling an investment property, or other asset during the same 12-month period.
Hellier says investors are entitled to a 50 per cent capital gains tax discount on profits provided the shares they sold had been owned for more than 12 months. This may be significant in timing a sale of shares.
Say an investor makes a $20,000 profit from selling shares. The investor will pay capital gains tax on $20,000 at the marginal rate if the shares were held for less than 12 months. But if the shares were held longer than a year prior to sale, then the investor pays capital gains tax on $10,000 because the discount applies.
While a loss may be difficult to swallow, doing nothing may turn out worse. The key is to minimise the damage of share losses. Gino Malacco, a partner of Hall Chadwick Chartered Accountants, talks about “extracting benefits” from losses in terms of offsetting capital gains. “You can’t get the benefit until you crystallise the loss,” he says.
Malacco says share losses, as a result of a company going broke and de-listing, can’t be offset against a gain until the liquidator or administrator declares the shares worthless. And, Malacco warns, this may take some time. Malacco also warns that the Australian Taxation Office may reject offsetting a loss against a gain if it considers the transaction merely a “wash sale”. This involves selling a stock at a loss, say as an example a bank, to purely offset a capital gain, say a miner, and then buying back the same bank at an almost identical trading price in very short time frame.
What investors should be do, perhaps more than ever, is closely examine what shares they’re holding and make an aggressive decision on whether to keep them. The consensus among accountants and finance planners we spoke to is the market is at or nearing the bottom. Renowned blue-chip companies with a solid earnings history generally recover over time.
Hellier says: “If you have the cash, buy good stock that everyone is selling. At these sharemarket levels, do the opposite to the herd mentality.”
In a sharemarket that’s lost 50 per cent of its value, buying good stocks now may be the most rewarding financial decision you’ll ever make. It may even, in the future, erase today’s losses from your memory.
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