An investing mistake I made, which I do not plan on repeating

By considering tax efficiency as well, you'll be on a smarter path to maximizing your investment success. (Image: Pixabay)
By considering tax efficiency as well, you'll be on a smarter path to maximizing your investment success. (Image: Pixabay)

Summary

  • Tax loss harvesting can significantly boost your returns. Embrace this strategy to optimize your tax outgo and enhance your portfolio's performance.

Call it ignorance or an "I don't care" attitude, but many of us, especially early in our investing careers, are all about chasing big, long-term growth. Along the way, we celebrate our successes and hang onto our failures for far too long, treating winners and losers in our portfolio separately.

However, the real oversight occurs when we let go of our losing investments without realizing the potential benefit. This isn't about the mistakes of selling too soon or holding on too long. These are for another day. The mistake I am referring to is failing to capitalize on the advantage that comes from letting go of loss-making investments from your portfolio. This overlooked benefit, which accumulates with each exit, can amount to a considerable sum over time. And, unfortunately, we leave that benefit on the table, i.e. we don’t claim it.

I should know. I've been guilty of this, focusing solely on returns and neglecting other aspects of the investment equation.

I'm no tax expert, but let's simplify this from a long-term investor's perspective. Imagine you've had a great year, and your long-term holdings have increased significantly, leading you to book profits. What you now have sitting on your books is a long-term capital gain. And in a few months, you will be paying a capital gain tax on it (if the gain is over 100,000).

My past self would've just paid the tax without a second thought.

However, there’s a perfectly legal way to try and optimise the tax outgo. It’s called tax loss harvesting. You are probably familiar with this as some brokers offer guidance on this.

But if you are not, this is how it works. Let’s get back to the example.

So, you have a gain, but then it’s likely that in the frenzy of 2022, you ended up buying some loss making, almost bankrupt EPC company stock, with the hope it will go up 10 times. Presently, however, it’s down sharply. Your friend’s friend who knows someone who knows the operator of the stock, says hold on to it. So, you are holding on to this.

Well, what you could do is book the loss on the EPC stock, by selling it. (And then of course you could buy back the stock.) The result?

You can now set off the long-term capital gain against the long term capital loss from your EPC stock. This would limit your tax liability. And, of course, your stock holdings remain the same (in case you buy back the stock). Of course, you have to bear some cost, but that’s tiny in the overall scheme of things.

This, dear investor, is a great way to optimise your taxes. Like I said, it’s called tax loss harvesting. You pay lower taxes today. And if your EPC stock does well, you effectively defer paying a larger tax liability in future. And in case it does not, well, you took advantage of the loss anyway.

It’s perfectly legitimate (at least that’s what I believe it to be). And something that over time will help you optimize the returns on your investments.

Like I said this is a very simplistic way of looking at tax loss harvesting. There are multiple angles to this – short term, long term, limits, carry forward criteria et cetera. What I hope this edition of Contramoney will trigger is two things:

First, log into your account with the broker, and see if they offer automated tax loss harvesting ideas for you. This could be a good trigger to get you started.

Second, I encourage you to have a conversation with your tax consultant (before they get really busy with tax season), and make tax loss harvesting a permanent check list item for your annual tax planning.

Don't repeat my early investing mistake of focusing solely on returns. By considering tax efficiency as well, you'll be on a smarter path to maximizing your investment success.

Happy tax planning to you!

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.

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