Why Am I Paying High Capital Gains When Market Returns Are So Low? by Paul Robertson, Tara Thompson Popernik, AllianceBernstein
This year, like last, US investors may find themselves in the disconcerting situation of facing significant net taxable capital gains, although the stock market is up only modestly for the year to date. How could this happen?
It’s a legacy of the bull market: With the S&P 500 up 225% from March 1, 2009, through October 31, 2015, most US stock-market investors have earned sizable capital gains. Normal portfolio turnover typically leads to realizing some gains each year, but for several years, many investors were able to offset those gains with losses carried forward from the 2008 market drop.
But for 2015 through November, the index has returned just 3%—and most investors have exhausted the loss carryforwards that sheltered past gains.
To defer paying capital gains taxes, some investors deliberately put off selling appreciated securities. That’s fine, up to a point. But holding onto stocks just to put off realizing gains may mean ignoring better opportunities that arise. You may end up owning stocks that no longer have an attractive future return profile: Few stocks go up for years without a drop.
There’s a way to manage your portfolio without letting the tax tail wag the investment dog: Buy and sell in a tax-aware fashion. We only take gains in client accounts when the potential return from selling and reinvesting outweighs the tax and transaction costs.
Making that determination isn’t easy; the optimal solution has to be tailored to each investor, for each account. For example, it may pay to hold on to an appreciated stock in a taxable account for an investor with a relatively short time horizon in a high-tax state, but we would sell that same stock in the investor’s non-taxable retirement account. Help with making decisions like this is one benefit of active, integrated investment management.
Lightening the Load
There are several ways to reduce the tax cost of portfolio sales in or after a bull market, as we explain in this video on year-end tax strategies.
Only a few of these techniques actually avoid taxation. Most, like loss harvesting, defer taxation to a later date. All of them should be considered in the context of each investor’s tax position and other circumstances.
The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.