It’s that time of year when our thoughts turn to turkey dinner and giving thanks for all
that we have. It’s time for apples and cider and the final harvests of autumn. It’s also
time to think about “harvesting” your portfolio!
All too often investors have a tendency to hold on to their winners and losers too long.
They don’t want to part with losers because they’re sure that as soon as they do, the
losing investment will rebound. They can’t stand the thought of selling and then missing
out on a miraculous recovery. They overlook the fact that if they sold the loser, they
could mitigate their loss by writing off the loss on their tax return and then replace the
poor-performing asset with one that has a better probability of providing a good solid
return going forward.
As for holding on to winners too long, investors have similar fears; what if they sell a
winner and then lose out on future gains? Or, they hold on to winners to avoid having to
pay taxes on their gains. Letting taxes get in the way of doing what’s right from an
investment standpoint is a common mistake. You need to establish a target selling price
when you purchase a stock. When it reaches that price, you should sell the stock
unless you can make a sound argument as to why that stock remains undervalued.
Keep in mind too, that with our current Congressional party make-up, the existing low,
long-term capital gains rate of 15% may not be around for long.
So, with the 2007 tax year coming to an end, it’s time to “harvest” your winners and plow
up your losers. If you focus on the tax savings from selling losers and the current low
capital gains rate, it will help motivate you to take action. Often the losses will offset the
gains and eliminate the capital gains liability.
Review your portfolio and look for assets with significant losses. It may be that the asset
is worth keeping but has a significant loss that can be used to offset the gains of a
winner than needs to be sold. Due to what’s called the “wash-sale rule”, you can’t just
sell the asset and then re-purchase it. IRS rules require you to wait 30 days before re-
buying, else you lose the right to write off the loss. There is a way around this rule,
however.
For example, let’s suppose you have a substantial holding in the Fidelity Spartan 500
Index fund that is down significantly due to a recent market downturn. You’d like to sell
the fund but want to maintain your position in large domestic stocks, in case of a market
rebound. You can sell the Fidelity fund and immediately buy a similar fund (such as the
Vanguard 500 Index Fund) without violating the wash-sale rule. In the case where the
holding is a stock, you may be able to find a similar stock in the same industry in order
to maintain your position in the market.
You also need to analyze your winners to determine those that have reached their
target selling price and should be sold. You should also look for stocks that have done
so well that they now represent more than 5% to 10% of your total portfolio’s value.
Often these holdings are in stock of the company you work for or have strong emotional
ties (e.g. inherited from your parent). Nevertheless, a stock holding of more than 5% to
10% of your portfolio adds significant risk that should be avoided. Having too much
stock in the company you work for is a big mistake. When times get bad, companies
layoff people or give early retirements. At the same time, your company’s stock price will
likely be low, just when you may need it the most. ”Harvest” time is a good time to trim
those holdings too, since losses from losers can help mitigate the taxes from possible
gains.
So this year and in the years to come, let the falling leaves be a reminder to take a look
at your portfolio and do some “harvesting”!
David C. Patterson, CFP® and Erin Patterson, CFP® are the owners of Patterson Advisors, LLC, a fee-
for-service-only financial advisory firm. Patterson Advisors, LLC is a Registered Investment Advisor,
registered with the State of Michigan, helping clients in Waterford, Clarkston and Royal Oak, Michigan
as well as other Oakland County, Michigan communities . Visit www.pattersonadvisorsllc.com for more
information or call 248-674-2108.
Published in the Oakland Insider, November, 2007
Time is Right to Harvest Your Portfolio
By David and Erin Patterson