Recs

5

Is This Really a Smart Move Now?

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Lots of people will do almost everything to avoid having to pay more taxes to Uncle Sam. But just because you want to protect your money from the IRS doesn't mean you should make boneheaded moves with your investments.

Pay now to save later
A recent article in Barron's highlights a problem that many people are struggling with: the possibility of higher taxes in 2011 and beyond. With tax cuts due to expire and everything hanging on a lame-duck Congress to fix the problem, some investors have simply decided to bank on higher tax rates coming back next year.

When tax rates are on the rise, taxpayers are in an unusual situation. Usually, it's smarter to put off paying tax as long as you possibly can. But what the Barron's article discussed was selling stocks with big capital gains now in order to lock in this year's 15% maximum tax rate on those gains, rather than potentially having to pay 20% or more next year if you wait to sell until after Dec. 31.

So far, that makes perfect sense: Selling now in the hope of eventually saving 5 percentage points in tax could be a smart move for some folks. What doesn't make sense, though, is the strategy the article suggests after you sell.

Why get complicated?
If your sole purpose is to reap a tax gain, you can simply sell your shares and then buy them right back again. There's no wash-sale rule for gains, so for the cost of a couple stock commissions, you can achieve your goal and end up with exactly the stock exposure that you had before the sale.

What the article suggests, though, is to buy long-term call options rather than repurchasing the stock. The article points to Netflix (Nasdaq: NFLX  ) , Apple (Nasdaq: AAPL  ) , and priceline.com (Nasdaq: PCLN  ) as ideal examples where this trade makes sense.

The problem with the strategy is that it fundamentally changes your investment. Rather than accepting the possibility of a complete loss in exchange for potentially unlimited gain, buying a call option involves paying a substantial sum of money upfront in order to avoid having to have any downside risk at all.

Don't pay for what you don't want
Now with stocks like those, an investment that limits your downside may make sense. Netflix is the first mover with an incredibly promising business model, but competitors Coinstar (Nasdaq: CSTR  ) on the physical DVD side of the business and Apple on the streaming side could put a dent in a stock that's priced for a perfect future. Similarly, Apple is riding high on its iPad and iPhone 4, but Google (Nasdaq: GOOG  ) Android-based phones are hanging tough, and Research In Motion (Nasdaq: RIMM  ) recently announced its PlayBook tablet would be priced competitively with the iPad.

But you pay a lot for that downside protection. The article talks about paying $37.84 per share – more than 20%! -- for Netflix call options expiring in January 2012. Just to break even, you'd need the shares to rise by more than that same $37.84 amount. And if the shares stayed flat, the option strategy would turn what would've been a break-even situation had you held onto your stock into a loss of your entire premium. The only way you end up better off with the call option is if the shares fall.

More importantly, tax strategies shouldn't be the reason for changing your investment strategy. Priceline, for instance, thrashes the competition quarter in and quarter out, while rival Orbitz Worldwide (NYSE: OWW  ) has actually seen its stock fall. Why pay a big premium for a call option if you don't believe there's any downside risk to just owning the stock outright?

Keep it simple
Options can be extremely useful tools to match up risk and reward the way you want. But if you're just looking for a way to max out your 15% gains, skip the options and just buy back your shares after you sell them. Sometimes, the simplest way is the best way.

Forget Apple and Netflix -- there's a new technology revolution going on, and you only need one stock you need to profit from it. Find out about it in this Fool free report.

Fool contributor Dan Caplinger finds writing about the IRS taxing. He owns shares of Apple. Google is a Motley Fool Inside Value pick and a Motley Fool Rule Breakers choice. Apple, Amazon.com, Netflix, and priceline.com are Motley Fool Stock Advisor selections. The Fool owns shares of Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy always looks for the better way.


Read/Post Comments (0) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 1367617, ~/Articles/ArticleHandler.aspx, 4/20/2014 10:45:17 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

Today's Market

updated 2 days ago Sponsored by:
DOW 16,408.54 -16.31 -0.10%
S&P 500 1,864.85 2.54 0.14%
NASD 4,095.52 0.00 0.00%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

4/17/2014 4:00 PM
AAPL $524.94 Up +5.93 +1.14%
Apple CAPS Rating: ****
BBRY $7.15 Down +0.00 +0.00%
BlackBerry CAPS Rating: *
GOOGL $543.34 Down -20.56 -3.65%
Google (A shares) CAPS Rating: ****
NFLX $345.74 Up +14.33 +4.32%
Netflix CAPS Rating: **
OUTR $65.52 Down +0.00 +0.00%
Outerwall CAPS Rating: ***
OWW $7.59 Up +0.11 +1.47%
Orbitz Worldwide,… CAPS Rating: *
PCLN $1208.36 Down -3.89 -0.32%
Priceline Group CAPS Rating: ***

Special Offer for Savvy Investors Like You!

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Ut semper dui vitae molestie venenatis. Suspendisse.

Enter Email Address:



Privacy / Legal Information
Advertisement