Author Topic: The 'Problem' of Capital Gains  (Read 5146 times)

This_Is_My_Username

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The 'Problem' of Capital Gains
« on: January 11, 2015, 10:31:37 PM »
This is a hypothetical example.

A) I bought a Thing for $100k, which gives me $4k annual cash income.  I am happy with my 4% yield.

B) Later, my Thing increased in value to $200k, and the annual cash income is now $5k.  I am very happy with my 5% yield on the original $100k investment, but I am sad that I am only receiving a 2.5% yield on the current value.

C) Later still, my Thing increased in value to $600k, and the annual cash income is now $6k.  I am very very happy with my 6% yield on the original $100k investment, but I am very sad that I am only receiving a 1% yield on the current value.

:

Is this a problem?  Should something be done?  What would you do?

bigchrisb

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Re: The 'Problem' of Capital Gains
« Reply #1 on: January 11, 2015, 11:04:10 PM »
I'd question why the market has dropped its discount rate for my thing so drastically!  In theory, a market price is essentially the net present value of all future payments, discounted to current dollars.  In practice, the discount rate used often swings wildly - both due to changes in opportunity cost, but also due to the psychology of markets.

In your example, what was a 4% yield on valuation has dropped to a 1% yield on valuation.  That would mean to me that the market thinks that some mix of the following are happening:
- The opportunity cost of capital has dropped a lot (this is the same theory of share prices rising when interest rates drop).
- There is an expectation that future cash flows will rise
- The market for my thing has taken on a "greater fool" approach - i.e. people begin to speculate on the premise of further capital gain (Aussie housing, anyone??)

In your example where the price has appreciated so much, and the income not so much, I'd probably end up re balancing some of my appreciated "things" into alternative things!

innerscorecard

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Re: The 'Problem' of Capital Gains
« Reply #2 on: January 11, 2015, 11:40:47 PM »
Some say that you should always ask of every financial asset you own, would you buy it today, given the present business and present price? Put differently, is a given asset worse than the amount of cash you would generate from selling it today, given the optionality value of cash?

Taxes do complicate the above picture significantly, given the big benefits to deferring the realization of capital gains. On the other hand, you don't want to simply lose those capital gains due to greedily holding onto an overvalued asset!

In your situation, it seems like the merits of the asset itself have grown far less than the merits of the asset's price, which means that it is either far less undervalued than it was when you bought it or actually overvalued now.

TomTX

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Re: The 'Problem' of Capital Gains
« Reply #3 on: January 12, 2015, 05:33:54 AM »
This is a hypothetical example.

A) I bought a Thing for $100k, which gives me $4k annual cash income.  I am happy with my 4% yield.

B) Later, my Thing increased in value to $200k, and the annual cash income is now $5k.  I am very happy with my 5% yield on the original $100k investment, but I am sad that I am only receiving a 2.5% yield on the current value.

C) Later still, my Thing increased in value to $600k, and the annual cash income is now $6k.  I am very very happy with my 6% yield on the original $100k investment, but I am very sad that I am only receiving a 1% yield on the current value.

:

Is this a problem?  Should something be done?  What would you do?

Can you sell (realizing cap gains) part of the Thing up to the top of the 15% bracket, thus resetting your basis higher and paying no taxes? Can you then rebuy an equivalent Thing?

Left

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Re: The 'Problem' of Capital Gains
« Reply #4 on: January 12, 2015, 06:15:33 AM »
um, why rebalance? I mean assuming this is in a large index fund or something? Didn't the posters on here that valued growth over dividends imply this is something that they preferred?

gt7152b

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Re: The 'Problem' of Capital Gains
« Reply #5 on: January 12, 2015, 07:18:59 AM »
This would have to be a non- liquid asset if the yield cannot tap into the appreciation of the asset. Let's say that you have to sell the whole thing to realize the appreciation. It all comes down to whether you need the income now or can wait until later. There is also a question of risk for future valuation. If it's a stable investment and you are satisfied with the current yield then there is no problem. If you are worried about locking in current value due to possible future volatility or you need more income now then it should be sold and invested in something with higher income and/or more stability. The original purchase price is irrelevant and should not influence your decision today.

rmendpara

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Re: The 'Problem' of Capital Gains
« Reply #6 on: January 12, 2015, 09:18:27 AM »
If you have other opportunities in the future case(s) you laid out to earn a higher yield with similar (perceived) future growth, then yes you may be better off if you sell part or all of that investment and roll into another.

Many other factors should be considered as well, such as your own level of preferred liquidity, preferred return targets, overall mix of stocks/bonds/etc, and so on...

In theory, any asset with positive real returns can enhance a portfolio's overall efficiency. Something to consider..

Overseas Stache

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Re: The 'Problem' of Capital Gains
« Reply #7 on: January 12, 2015, 11:53:27 AM »
If your "Thing" is a rental property than your example could easily happen. In which case it would probably be best to access the equity through another loan and invest the funds, if you can find another investment that will give a better return then the interest rate on the loan.

waltworks

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Re: The 'Problem' of Capital Gains
« Reply #8 on: January 12, 2015, 06:07:42 PM »
I have this problem, though not to the extent you do (or at least not to the extent of your hypothetical) - rental properties that have appreciated to the point that they are 1/2% rule, at best.

My personal solution is to sell them. I knew I was making an appreciation play to some extent and the money can work harder elsewhere. Yes, I'll pay some cap gains. C'est la vie. Not a terrible problem to have!

-W

YoungInvestor

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Re: The 'Problem' of Capital Gains
« Reply #9 on: January 12, 2015, 06:26:23 PM »
Depends, really.

If your thing is worth 600k, and you would pay 15% taxes on the full capital gains (15% of 500k = 75k$), you would need another thing with that buys at least 6k/yr. and will appreciate as much as your original thing (or something that has the same or a better ROI, whatever the combination of yield/appreciation is) for 525k$ for it to be worth it.

goodrookie

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Re: The 'Problem' of Capital Gains
« Reply #10 on: January 13, 2015, 02:53:48 AM »
Law of large number. Learn to deal with it.

When capital investment is higher, accept lower return and aim for capital preservation. Although most people do it the other way.

innerscorecard

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Re: The 'Problem' of Capital Gains
« Reply #11 on: January 13, 2015, 02:56:04 AM »
Law of large number. Learn to deal with it.

When capital investment is higher, accept lower return and aim for capital preservation. Although most people do it the other way.

You shouldn't have that problem until you reach in the tens of millions at least. I think This_Is_My_Username was talking about a different problem entirely.

This_Is_My_Username

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« Reply #12 on: January 13, 2015, 10:47:56 PM »
thanks for all the comments.

it seems like a popular view is to sell for 600k, and buy something else that returns 4% (24k).  Of course this would depend on the specific details of the investment, and the local laws, and tax.
« Last Edit: January 14, 2015, 03:50:35 AM by This_Is_My_Username »

dungoofed

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Re: The 'Problem' of Capital Gains
« Reply #13 on: January 14, 2015, 02:41:52 AM »
My colleague living in Hong Kong just had her rent increased 40% (?!), the reason given was that the rent had to reflect the increased value of the property.

I don't know what your thing is but if you're able to increase the rent then that might be an option.