Waypoint’s Bringing Order to Your Investment Universe: Part 2: Transitions and Taxes

As we touched on in The Beauty of Being Organized [Click to read)], when you sell an investment for more than you paid for it, there can be burdensome capital gain taxes realized in the year of the sale. How do you manage for this challenge? It helps to identify which trades can be placed promptly, and which may be better managed over time.

 Easy Assignments

Here are two conditions under which you should be able to fast-track your transitional trades:

 In Tax-Sheltered Accounts: Depending on the account type, you may pay ordinary income taxes when you eventually take money back out of a tax-sheltered account. But there are no tax consequences to the trades you make within these accounts along the way. Because realized gains are not taxed in your tax-sheltered accounts, we can usually place trades promptly within any of them.[1]

 In Taxable Accounts: In your taxable accounts, we can sell targeted positions that have not grown much in value over time, since these trades will incur few, if any taxable gains. If a holding has actually declined in value, you may even be able to incur a capital loss on it, which can be used to offset gains incurred elsewhere.

 Deliberate Decisions

What if your plan calls for selling taxable positions that have substantially appreciated (gone up in value)? It’s not as easy to decide whether and when to trigger these taxable gains. Should you sell sooner than later? Bide your time? Skip it entirely? Let’s look at each possibility.

 Selling Sooner

Nobody enjoys paying taxes. But remember …

 Tax Costs Are Relative: Moving toward a low-cost, tax-efficient, well-structured portfolio should leave you better positioned to earn the highest expected returns for the costs and other risks involved. If a careful analysis suggests the expected rewards should readily outweigh the upfront costs, it may make sense to go ahead and pay those taxes anyway.

 Your Mindset Matters: The sooner you’re able to sell positions that are no longer serving your needs, the sooner you can establish a better sense of control over your money. With the improved clarity, you’re less likely to make costly, “buy high, sell low” investment mistakes in ever-moving markets. Failing to invest consistently can cost far more than the tax hit you may need to take to acquire greater investment resolve.

 You’re Buying Low and Selling High: If you sell a position for a taxable gain, you’re also locking in a profit. Since that’s exactly what an investor ultimately wants to do, it may be worth paying reasonable taxes to periodically take some of your overweighted “winnings” off the table.

 Biding Your Time

So, yes, there are times it may make sense to pay some upfront taxes to speed your plan along. Other times, it may make more sense to take a multiyear course toward your ideal transition. By preparing to sell targeted positions across several years, you may be able to strike a happy medium between minimizing the impact on your annual tax rates while successfully moving toward your preferred portfolio.

 “Pretty Nice” May Need To Suffice

Your plan also may include keeping some of your less-ideal investments indefinitely. Even if a holding isn’t THE perfect position for the job, close enough may be good enough if the tax and/or trading hurdles are high enough. Also, some of your net worth may be tied up in an employer’s retirement plan, equity incentive program, or similar account where your choices are limited. These assets still need to be considered within your overall portfolio, but may call for a different level of planning.

 Bottom line, don’t be blindsided by taxes. But neither should an aversion to taxes blind you to the practical and emotional costs of clinging to a position longer than warranted. Fortunately, there are many ways to manage a smoother transition. We’ll cover some of them next in Part 3. 

[1] Tax-sheltered accounts include traditional, Roth, SEP, and other types of IRAs; 401(k) and 403(b) employer plans; and similar types of accounts.