Between earthquakes, hurricanes, and whatever else Mother Nature may throw at you this week, trying to save money on your tax return for this year is probably just about the last thing on your mind. But even though you still have four months to go before the end of 2011, now's actually the perfect time to plan for how you can make the most of losing investments that you've suffered so far this year.
In fact, if you get your tax act together now, you might well beat the rush of last-minute procrastinators trying to get in under the December deadline. That can mean not only tax savings but more money in your pocket.
A big reversal
Until last month, many investors weren't thinking about tax losses at all. With the broad market indexes pushing their highest levels since before the 2008 market meltdown, plenty of investors were riding high with significant gains on their stocks.
But that all changed with the recent market correction. The decline has been brutal in its scope:
- The telecom industry has started to polarize, turning into a battle of haves versus have-nots. Sprint Nextel (NYSE: S ) and MetroPCS (NYSE: PCS ) , which many see as being on the outside of the in-group in telecom, have both lost more than 35% of their share value in just the past month.
- After a fairly good couple of years for the technology sector, several tech stocks have reversed course dramatically. Hewlett-Packard (NYSE: HPQ ) now seems rudderless as it moves away from its PC business, while networking stocks Akamai (Nasdaq: AKAM ) and Juniper Networks (NYSE: JNPR ) have had to deal with a combination of increased competition and missed expectations. All three have lost about a third of their value.
- More generally, stocks that can't meet investor demands are getting taken to the woodshed quickly and decisively. E*TRADE Financial (Nasdaq: ETFC ) is down 33% in the past month after falling short on trading activity levels in its most recent quarter. Monster Worldwide (NYSE: MWW ) was the biggest loser in the S&P 500 over the past month, dropping 44% on lousy unemployment news and concerns that more specialized competitors have the inside track to growth.
In other words, if you've done any investing this year, you probably have some losers on your hands. Fortunately, there's a way to get at least some of those losses back.
Making lemonade
The key to salvaging losing stocks comes from tax rules for capital losses. By selling losing stocks, you can apply those losses against any capital gains you have on winning stock sales. Moreover, if you have more losses than gains, you can take up to $3,000 each year to offset other types of income. You can usually carry forward any extra losses into future years.
So why worry about this now? The first reason is that if you wait until November or December, thousands of other losing shareholders may already have sold out, potentially pushing share prices down even further and leaving you with an even bigger loss. By being first out, you can beat the crowd and get a relatively high price for your shares.
The second reason, though, applies if you think your losing stocks will rebound. In that case, selling outright may not seem like a smart move. Because of complicated rules covering what's known as wash sales, you can't simply sell the stock and buy it right back. But you can buy more shares now -- essentially doubling down on your investment -- and then sell the original higher-cost shares after 30 days have passed.
Alternatively, you can use exchange-traded funds to avoid the wash sale rule. For instance, if you have a lot of losing tech stocks like HP, Akamai, and Juniper, then you could sell the individual stocks, and buy a technology sector ETF that holds those stocks, along with other industry peers. It won't be a perfect match, but odds are good that if those companies recover, the entire ETF will as well.
Don't wait!
It's hard to watch your stocks lose value. But letting Uncle Sam shoulder some of the burden with you makes it at least a little bit better. By taking advantage of tax-loss selling sooner than later, you can make the best of a bad situation.
You can't avoid losses on all your stocks, but you can improve your odds. Read the Fool's free special report, "5 Stocks the Fool Owns -- And You Should Too," and build a better portfolio today.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.
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