The Worst Trade I Ever Made… and How You Can Benefit

Original post

In December 1996, I sold my shares of Best Buy (NYSE: BBY).

I still consider it one of the most boneheaded investment moves I ever made.

A year later the stock was up more than fivefold. A few years later, it was up more than thirtyfold.

The worst part is I liked the business prospects for Best Buy at the time.

I sold it only because I had taken substantial capital gains earlier in the year and was cleaning out my portfolio to offset them with realized losses.

I don’t always do that anymore. And you shouldn’t necessarily either.

Despite what your tax advisor may tell you, you should never sell an investment for tax reasons alone. Nor do you have to.

The IRS allows you to offset realized gains with realized losses each calendar year.

If you do, however, you must wait at least 30 days before buying them back. (Otherwise you run afoul of the wash-sale rule.)

Offsetting gains at the end of the year is generally a sensible move. Your tax bill will be lower. Most stocks are not appreciably higher 30 days later. And trading costs and spreads are negligible these days.

If you still like a stock, you can scoop it back up a month later.

However, there is a risk, and it’s called the January effect.

The first month of the year is traditionally a strong one for the market. A lot of pension and IRA money gets invested early each year. Plus, there is often a rebound from the tax-loss selling that happens each December.

If a stock you own soars in January, there is a natural reluctance to buy it back. The temptation is to wait until it comes back down.

But it may not. In that case, you sold an investment with unlimited upside potential to take a limited loss.

There is a way around this problem, however. But you have to act on it within the next five days.

Let me explain…

In late November each year, I look at my entire portfolio for any companies trading below my purchase price. If I still like their prospects, I often double down on them for 30 days.

Why? Because I can sell the original shares at the end of December for a tax loss – and not be forced out of the stock for a month by tax rules.

If the market rallies strongly in January – as it often does – it’s not a problem.

After all, thanks to my November purchase, I own the same number of shares that I bought originally but with a lower cost basis.

This strategy is especially compelling if the market has just undergone a correction as, of course, it has.

What if you don’t have the cash available to double down on those positions?

In that case you should do something I rarely recommend: Use margin.

Again, I’m recommending this only for a 30-day period. Your margin interest charge – especially with rates at these levels – will be minimal.

The risk, of course, is that your new shares will be worth less a month from now.

But you’ve still established a lower cost basis on those shares. And, of course, the opposite may happen.

The January effect is often preceded by the Santa Claus rally, the tendency of the stock market to do well in the second half of December.

As a result, you could very well have a paper gain on your new purchase.

(The Santa Claus rally is never certain, of course, and another reason you should add to only those companies whose business prospects remain strong.)

Bear in mind, when you’re selling for tax purposes, the IRS requires that you buy the identical shares at least 30 days before you sell the others.

So if you want to use this strategy for 2018, you must act within the next five days – and wait until the last week of the year to take a loss on the original shares.

If we have the traditional mid-December to early February rally, you’ll thank me.

And perhaps again on April 15.

Good investing,

Alex

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