Help with an old investment

[tannybrown]

Hi there,

My wife and I are hoping to leverage the collective knowledge of the MMM forum for an old investment we have.  My wife had an inheritance from her mother that, when we started dating 5 years ago, was just sitting in a savings account. So, being the smart guy that I was, I told her to go put it in a mutual fund.  No idea what kind, but I figured the fine people at Wamu could advise us. 

Into a branch we went with $61k in cash, out we came with a class A mutual fund, SABPX (edited), charging us 5% on the front end.  This was in early 2008, more or less the peak of what this mutual fund has ever seen.  On comes the recession, the $61k dips into the high thirties, but we don't sell, and still haven't.

Today, it's back up to $51k, roughly 10k in unrealized losses.  Every few months we have a discussion for what to do...continue to hold on to the investment until we get back to even?  Or lock in our losses, and put the funds into the current asset allocation we have:

Coward's Porfolio:
25% VFINX
25% NAESX
25% VBISX
25% VDMIX

Here's the high level view of our financials that may help:

-We are in the 15% tax bracket so we only put in 5% pre-tax my 401k, and get a 5% match from the company; aiming for the same asset allocation above
-We also make a 5% Roth 401k contribution into the same plan
-Max out both her Roth IRA and mine
-$65k left on the mortgage
-Wife is in a PhD program so she doesn't earn an income, beside a small stipend
-Will likely be moving in 5 years when she starts applying for professor positions...may want to use these funds for downpayment
-May want to keep and rent out the current house in that case
-No debt besides mortgage, no kids

Thanks in advance for your help!

[gooki]

Are there any fees or additional taxes if you cash up your current investment? If not, then sure cash it up and spread it across your other investments.

[astadt]

Ugh, i bet that banker was sure proud of him/herself for scamming you. Man...

I would use it to max out my Roth 401k (minus your 5% for your regular 401k) this year and invest the rest in taxable accounts.

If you wanted to make sure you get the most of your tax benefits from it, you could build a 2 year cd ladder and use the money coming out of that to dollar cost into your future years Roth 401k.

[tannybrown]

Thanks for the quick feedback!  Some follow up questions:

-As we're already maxing out both of our Roths, it seems that ultimately we'd need to just find a place for that $5k in each Roth to go, whether it came from the investment or paychecks.  I'm hesitant to make a single buy...any advantage of using the SABPX funds rather than paychecks?

-I'm no tax expert but it seems we'd have a capital loss of $10k...with no captial gains anywhere near that amount.  What's the right strategy re: capital losses?

[smedleyb]

Tanny, Sapbx appears to be a general market fund; aside from getting robbed when you bought into the fund, I don't see what you'd gain by selling it and then dumping the money into those other funds, which are themselves general funds, although one focuses on the S&P500, the other on midcaps, etc.  You're just making the same bet, albeit through different fund vehicles.

Let me ask you this:  did the extreme volatility of the moves of the past 5 years cause you a lot of stress?  If so, then there is nothing to be ashamed of if you want to sell that fund, write off the loses (carry them over for when you have gains), and let the money sit in a cash account. 

[tannybrown]

Right, the 5% is a sunk cost so that's done and over with.  But can you further explain the "carrying over capital loss" bit?  I'm completely lost as to how that works -- how much can you carry over, for how long, etc.  Can you create an example to illustrate?

[grantmeaname]

It's your money and you can do whatever you please with it, if you really want. But keep in mind, buying high (because you're thrilled your stock appreciated) and selling low (because you're heartbroken it dropped) are two big reasons that amateur investors underperform the market! Keeping it in cash when it's down is likely the worst thing you could do.

Tannybrown: Capital gains and losses are realized only when the investments are sold. The longer you don't sell it, the longer you are "carrying over" the capital loss. If you sell it, you immediately have made a capital gain or loss equal to the difference between purchase and sale price. EDIT: SmedleyB has a nice IRS document that explains you can also defer the capital loss deduction after you make the sale.

If you buy stock worth $10k, then its value plummets to $6k, you haven't realized your capital losses. When you sell it, you get to write off a $4k capital loss. Alternately, you could just wait longer for it to recover. Maybe you sell it two years later at $10.5k, so your capital loss write-off is gone and you realize a $500 gain instead...

[smedleyb]

Right, the 5% is a sunk cost so that's done and over with.  But can you further explain the "carrying over capital loss" bit?  I'm completely lost as to how that works -- how much can you carry over, for how long, etc.  Can you create an example to illustrate?

If your capital losses exceed your capital gains, the amount of the excess loss that can be claimed is the lesser of $3,000, ($1,500 if you are married filing separately) or your total net loss as shown on line 16 of the Form 1040 Schedule D, Capital Gains and Losses. If your net capital loss is more than this limit, you can carry the loss forward to later years.[/b]

http://www.irs.gov/taxtopics/tc409.html

[smedleyb]

It's your money and you can do whatever you please with it, if you really want. But keep in mind, buying high (because you're thrilled your stock appreciated) and selling low (because you're heartbroken it dropped) are two big reasons that amateur investors underperform the market! Keeping it in cash when it's down is likely the worst thing you could do.

Uh, the market is up nicely from the lows.  The fund has practically doubled off the bottom for Tanny.  Selling here and now is hardly selling when it's down.

Again, the disrespect for cash around here is amazing, especially given the massive uncertainties in the global and domestic economy.

[skyrefuge]

Tanny, Sapbx appears to be a general market fund; aside from getting robbed when you bought into the fund, I don't see what you'd gain by selling it and then dumping the money into those other funds

In that case, tannybrown can "gain" $1050 a year in reduced expenses.  Yeah, there's nothing that can be done about that up-front 5% robbery, but there's still a year-to-year robbery going on with the 2.1% expense ratio on SAPBX.  Put the money in VFIAX instead (which SAPBX basically seems to track with) and its 0.05% expense ratio is nearly an automatic performance increase going forward of 2.05%.

Normally, yeah, buying high and selling low is a bad thing, but in this case if the money goes to immediately buy essentially the same investment, then it seems like it's really more of a "transfer".  And then it's actually better to make that transfer now, when there is a capital loss rather than a capital gain for tax purposes.  (this seems a little too good to be true, and sure enough, I just learned that "wash sale rules" are what prevent this particular loophole from being exploited.  Still, even if they apply to this situation, losing the opportunity for a tax deduction is still better than paying a capital gains tax).

I've never really thought about this stuff before, and the "sell now when the price is down!" still feels slightly uncomfortable to type, so someone please correct me if I'm totally screwed up!

[skyrefuge]

Oh, wait, now I'm confused, are we talking about SAPBX (Legg Mason ClearBridge Appreciation B) or SABPX (Principal SAM Balanced A)?  I'm guessing the latter, since that's the one that's Class A.  In that case, the expense ratio difference isn't quite as extreme as I originally thought, and SABPX isn't in the same category as VFIAX.  If you wanted to do the same sort of "transfer" I initially described into a similar fund with a lower expense ratio, I guess it's close to VBIAX.  The expense differential is 1.35% - 0.10% = 1.25%, so only $638 saved per year, but still worth the switch IMO.

In all this I'm making the assumption that you want to keep your overall asset allocation where it is; I think it's easier to look at the issue if you separate it into two issues, #1) how to save on expenses #2) what should your asset allocation be.  So I'm ignoring #2 in all this.

[tannybrown]

Sorry to fat finger that -- it's SABPX.  It seems clear that we can reduce expenses by moving the funds to an index fund w/Vanguard.

It seems we can carry over the $10k loss into future years, to potentially offset any capital gains we have.  But, to be honest, I don't anticipate we'll be selling any funds outside of the 401k/IRAs soon, so it's hard to imagine this happening soon.

Can you carry over that loss indefinitely?  E.G. - 10 years down the line, we are beginning FI, and we sell funds in a brokerage account...using that $10k to offset the gains?

Additionally, we always end up taking the standard deduction as we have no children, don't own a business, have no student loans, and pay only $3500, approx, in home interest.  Not many deductions...so maybe the capital loss is a moot point?

[gooki]

I'm not from the US, so it's likely I'm wrong. I would have assumed you'd offset the capital loss against you income for the year, and thus pay less income tax.

[Chris]

Can you carry over that loss indefinitely?  E.G. - 10 years down the line, we are beginning FI, and we sell funds in a brokerage account...using that $10k to offset the gains?

Additionally, we always end up taking the standard deduction as we have no children, don't own a business, have no student loans, and pay only $3500, approx, in home interest.  Not many deductions...so maybe the capital loss is a moot point?

You can carry the loss year-over-year until you use it. Just keep track of it when you file your annual return.

The loss is used when figuring your capital gains for the year. It can only be used to reduce a gain, not any other income, so itemizing or taking the standard deduction is irrelevant.

One way to take advantage of the loss is to "rotate" one of your existing positions. Buy more shares of one of your existing positions where you have a gain, then sell some of your older shares. The gain earned on the sale of your long-term shares can be offset by your loss.  The result will be that you've cashed out a gain, avoided taxes on that gain, and kept your share allocation the same.

[tannybrown]

Thanks, Chris.  That's just what I was looking for.

Presumably, once the "new investment" (whatever allocation I put it in) gains back that $10k, I believe I would use that carry over loss to cancel out that new $10k in gains.  In the end, it sounds like this will just allow us to get back to even without any tax consequences.  Seems fair enough.

[skyrefuge]

The loss is used when figuring your capital gains for the year. It can only be used to reduce a gain, not any other income, so itemizing or taking the standard deduction is irrelevant.

Ok, I've never actually had a capital loss, so I'm dangerously speaking with only Google-knowledge rather than experience, but it the way I read it, the IRS disagrees with this:

8. If your capital losses exceed your capital gains, the excess can be deducted on your tax return and used to reduce other income, such as wages, up to an annual limit of $3,000, or $1,500 if you are married filing separately.

Of course, the standard deduction still may make the itemized capital-loss deduction irrelevant in tannybrown's case.

And yes, there is no limit to how many years you can keep carrying over capital losses, but you "use" part of it every year.  You can only carry over what's left after the $3k yearly deduction is taken (whether you actually benefit from that deduction or not): IRS sez "When you figure the amount of any capital loss carryover to the next year, you must take the current year's allowable deduction into account, whether or not you claimed it and whether or not you filed a return for the current year."  So with a $10k loss, after the 4th year, there will be nothing left to carry over.

So I guess maybe you do get a bit screwed in your situation, because the capital gain that you'll eventually pay when you sell, say, VBIAX 30 years from now, will be greater than the gain you would have if you just held SABPX for the long-term, and you won't have the ability to take advantage of the capital loss to counter that effect.  Chris's "rotation" suggestion then would be a way to take advantage of that capital loss, as long as it doesn't somehow violate wash sale rules.

[Chris]

Ok, I've never actually had a capital loss, so I'm dangerously speaking with only Google-knowledge rather than experience, but it the way I read it, the IRS disagrees with this:

8. If your capital losses exceed your capital gains, the excess can be deducted on your tax return and used to reduce other income, such as wages, up to an annual limit of $3,000, or $1,500 if you are married filing separately.

Thanks for the correction. I was remembering the rule for gambling losses (is it bad that my mind equated "investing" with "gambling"?).

Of course, the standard deduction still may make the itemized capital-loss deduction irrelevant in tannybrown's case.

The capital loss deduction isn't itemized; it is an above-the-line deduction, and would be useful as long as the taxpayer has a tax liability.

[tannybrown]

So that I'm clear, it sounds like every year I can effectively lower my taxable income by $3,000, regardless of the fact that I take the standard deduction?  If so, that sounds like the best path for me to go down.

[skyrefuge]

The capital loss deduction isn't itemized; it is an above-the-line deduction, and would be useful as long as the taxpayer has a tax liability.

Ah, and thanks for *your* correction!  That's where my "never actually done this before" caught up with me.  Now looking at an actual 1040 form, yep, there it is, way up there on line 13.

So that I'm clear, it sounds like every year I can effectively lower my taxable income by $3,000, regardless of the fact that I take the standard deduction?  If so, that sounds like the best path for me to go down.

Yep, I now retract my statement that you "do get a bit screwed in your situation".  The deductions you can take over the next 3+ years should cancel out (maybe more than cancel out?) any increased capital gains taxes you'll have to eventually pay due to such a transaction.  Only took 3 or 4 smart people going back and forth to arrive at this conclusion, so maybe wait a day or two to see if another smart person comes along to tell us we're all idiots.  :-)

[grantmeaname]

Folks, this is why CPAs and tax lawyers make the big bucks.

[tannybrown]

Hi all: follow up question.

I've read a bit about 'tax harvesting' and was hoping someone with experience can guide me.  If we were to sell SABPX at a $10k loss, wait 31 days, and then buy low cost index funds to fit our asset allocation, is that the correct process to avoid a "wash sale" so we can claim a capital loss? 

[MrSaturday]

Hi all: follow up question.

I've read a bit about 'tax harvesting' and was hoping someone with experience can guide me.  If we were to sell SABPX at a $10k loss, wait 31 days, and then buy low cost index funds to fit our asset allocation, is that the correct process to avoid a "wash sale" so we can claim a capital loss?

A wash only applies to rebuying the same stock or fund.

[Chris]

A wash only applies to rebuying the same stock or fund.

It's actually broader than that.

The IRS uses the term "substantially identical".  If it is exactly identical, then your broker will likely report it as a wash sale. But if it is substantially identical, it may be a wash sale, though your broker will not report it as such. It is up to you to identify wash sales on your taxes.

"Substantially identical" basically means that you have the same economic exposure and risk for both securities. If you sell an S&P500 fund managed by Fidelity for a loss, then buy an S&P500 fund managed by Vanguard within a 30 day window, that's counts a wash sale, even if your broker doesn't report it as such. If you get audited, you need to have a decent argument for the IRS examiner about why your risk exposure was different.

tannybrown: if you wait 31 days, you can buy whatever you want; the wash sale rule only matters within a 30-day window.

[tannybrown]

It does seem waiting the 31 days is the safest thing, but I don't like the risk associated with picking the wrong month to take that money out of the market.

As the funds I'd be splitting the funds between are diversified index funds and none are a Class A fund, I'd argue they're not "substantially identical" but I'm a babe in the woods here.  Having already made one mistake with this money, I'd like to avoid another. :)

[smedleyb]

It does seem waiting the 31 days is the safest thing, but I don't like the risk associated with picking the wrong month to take that money out of the market.

As the funds I'd be splitting the funds between are diversified index funds and none are a Class A fund, I'd argue they're not "substantially identical" but I'm a babe in the woods here.  Having already made one mistake with this money, I'd like to avoid another. :)

Your reading way too much into it!  The wash rule applies to individual stocks/funds.  A stock and an option on that stock are "substantially identical."  A stock and another stock in that industry are not "identical" at all!

The wash rule applies only if you buy SABPX in the next 30 days; and even then, it's not like you can't take the loss, so to speak.  The loss is added to the cost basis of your new purchase.  E.g:  I buy XYZ for 1K, then sell it for $500.  I then buy the same amount of shares the next day for $500, but my actual cost basis is the $500 + the $500 loss, or 1K, my original investment amount.  Thus for tax purposes, you don't get taxed on any "profits" until XYZ is  back over $1000 in value.

And if you stay away from SABPX -- and I really think you should -- none of this wash rule stuff matters anyways.

I repeat, cash is an asset too.  You might not make much, but sometimes "not losing" is preferable to "winning."  Especially when the money might be earmarked for other purposes in the future (home purchase).  And last time I checked US equity markets are still in a long-term bear within which is nestled our current cyclical bull (and a weak bull at that, one that needs trillions in governmental and central bank stimulus to stay afloat). 

It's hard out there.  I'm the first to admit that.   

[grantmeaname]

last time I checked US equity markets are still in a long-term bear within which is nestled our current cyclical bull

You state this like it's totally self-evident or you've supported it elsewhere on the site with something more substantial than your opinion.

[smedleyb]

last time I checked US equity markets are still in a long-term bear within which is nestled our current cyclical bull

You state this like it's totally self-evident or you've supported it elsewhere on the site with something more substantial than your opinion.

The market (SPX, DJIA) has been sideways with a downward bias since 2000.   The tech heavy NDX is half the level at its peak (March 2000).

I think 12-13 years of no meaningful progress qualifies as a bear, don't you?

The cyclical bull started in March 2009, and has brought us to this point.  In every bear market there are counter-trend rallies.  The Nikei 225 has had 4 100% rallies since peaking in 1989 (but overall it's still just a fraction of what it was at it's peak -- again, cyclical bulls couched in long term bears).



 

[grantmeaname]

Really, you're cherry picking the height of the bubble as the point a decade ago you compare to? Wow, that's solid evidence with real numbers, and you've got me convinced!

I could just as easily say we're investing today in the greatest American financial renaissance in history, because the Dow is up 78% in just the three short years since March 6, 2009! Yes, the numbers are factually true, but you've got to be totally tone-deaf or willfully misleading people to miss the implications of the fact that you picked the peak of the bubble to compare today to.

[arebelspy]

And the interesting thing is, I have no idea which of you is right.  But I tend to side with MMM about optimism > doom and gloom.

Either of you could be correct though, and there's really no way to tell until we have some hindsight.  I sure don't have a working crystal ball.

Quibbling over if we're in a bull or bear market seems pointless to me, because we can't know what we're in at the moment, only what we have been in at the past.

[smedleyb]

And the interesting thing is, I have no idea which of you is right.  But I tend to side with MMM about optimism > doom and gloom.

Either of you could be correct though, and there's really no way to tell until we have some hindsight.  I sure don't have a working crystal ball.

Quibbling over if we're in a bull or bear market seems pointless to me, because we can't know what we're in at the moment, only what we have been in at the past.

And remember folks, if Arabelspy don't know it, well then its either: (a) unknowable, or (b) not worth knowing:

A market trend is a putative tendency of a financial market to move in a particular direction over time.[1] These trends are classified as secular for long time frames, primary for medium time frames, and secondary for short time frames.[2] Traders identify market trends using technical analysis, a framework which characterizes market trends as predictable price tendencies within the market when price reaches support and resistance levels, varying over time.

http://en.wikipedia.org/wiki/Market_trend

Of course you don't know what kind of market we're in because making that determination requires some rudimentary understanding of technical analysis, which you simply don't have.  So either (a) read up on it, or (b) stock attacking poster who actually know what they are talking about.

[smedleyb]

Really, you're cherry picking the height of the bubble as the point a decade ago you compare to? Wow, that's solid evidence with real numbers, and you've got me convinced!

I could just as easily say we're investing today in the greatest American financial renaissance in history, because the Dow is up 78% in just the three short years since March 6, 2009! Yes, the numbers are factually true, but you've got to be totally tone-deaf or willfully misleading people to miss the implications of the fact that you picked the peak of the bubble to compare today to.

Height of the bubble?  The SPX and DJIA make higher highs in 2007.  Your ignorance of the history of prices is staggering. 

[grantmeaname]

Stop being facetious. "the" bubble clearly refers to the dotcom bubble, which everyone in the world but you conceives as a separate (not totally unrelated, but separate) event from the housing bubble and ensuing subprime collapse. When I said you were unfair in choosing the height of "the" bubble to compare, I meant that it was disingenuous of you to pick the absolute highest day that was about a decade ago as your basis of comparison instead of a typical day or even whichever day happened to be a decade ago, typicality be damned. That doesn't depend on the early 2000 peak being an absolute high-water mark for the indices for all of time, nor does the rest of my argument. If your point was valid, it would stand for most of the days a decade ago, including days other than the record high. Again, either you're impossibly dense (you're not) or you're willfully misleading people by misquoting the data to make your position seem like it's supported by the facts.

[arebelspy]

And remember folks, if Arabelspy don't know it, well then its either: (a) unknowable, or (b) not worth knowing

You just can't have a discussion without attacking someone, even when they're saying you might be right, huh?

FWIW, I think we're on the cusp of the next trend, and I could honestly see it going either way. But go ahead and attack me again for not having absolute knowledge of the future, like you apparently do.

[tannybrown]

Thanks, guys.  Because of this thread, I now hate the internet.

For every snide comment I read here from now on, I will make an un-Mustachian purchase.  It might be a ridiculous steak dinner...I might buy an extended warranty...I might lease a car.

If you care about me, you will end this. :)

[arebelspy]

Hah. Sorry for the negativity tannybrown. I think we'll give you the final word on this topic.

My apologies for any negativity on my part.

We aren't really making progress, just causing ill will.

I'm going to lock up these threads. Anyone wishing to discuss further can use PMs. Any objections, PM me.

Cheers all!