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If you're like most people, you probably think the right time to start thinking about your taxes is when April rolls around on your calendar. But by making the most of your bad investments before everyone else starts thinking about taxes, you can get a much better result for your portfolio's returns than you would if you procrastinate. Let's take a look at this tax-saving strategy and why it might pay to do it sooner rather than later.
Make the most of your losses
U.S. stocks are up huge so far in 2013, and so many investors haven't really had to think very much about losses in their portfolios. Yet if you've been unfortunate enough to own stocks in lagging industries like commodities or in companies that have faced specific challenges of their own, then you need to start thinking about the benefits of doing your tax-loss selling before your peer investors start thinking about it.
Losing money in stocks is never fun, but the silver lining is that you can take capital losses by selling losing stocks that you can then use to offset other investment income. If you have capital gains on other investments, then you can use losses to offset those gains. If you don't, then those losses can apply to reduce taxable income up to $3,000, potential offsetting income from interest, dividends, or your salary. Depending on your tax bracket, smart use of capital losses can save you thousands of dollars on your tax bill.
Why not wait?
Most taxpayers wait until November or December to start thinking about tax-loss selling. For tax purposes, it doesn't make any difference when during the year you sell as long as you get it done before Dec. 31. But when many investors are all in the same boat, all the selling pressure can actually depress losing stocks even further. Getting your selling done early can help you get a better price by putting you ahead of your peers. Moreover, with some mutual funds aiming at Oct. 31 as their deadline to get sales done, thinking about it as early as July isn't a bad strategy.
It's not hard to identify good candidates for tax-loss selling. Throughout the commodities industry, plunging prices have caused big share-price declines. Cliffs Natural (NYSE: CLF ) , for instance, has lost more than half its value since last October as the company has suffered from a big decline in demand for metallurgical coal and iron ore for steel production. It's also had to slash its dividend and curtail some of its production facilities in order to keep costs down. Similar stresses have hit Newmont Mining (NYSE: NEM ) and Freeport-McMoRan Copper & Gold (NYSE: FCX ) , with the April plunge in gold prices only exacerbating adverse trends that the companies have faced for more than a year now.
In addition to commodities, some stocks have sunk on company-specific news. Intuitive Surgical (NASDAQ: ISRG ) has lost about 20% since last October on concerns from both doctors and regulators about the efficacy and value of its robotic surgical systems for basic procedures. In retail, J.C. Penney (NYSE: JCP ) continues to struggle even with a new person in the CEO seat. These stocks all look like good candidates to see follow-through tax-loss selling throughout the remainder of the year.
You might also find loss candidates among bond funds. With interest rates having risen sharply, bond prices have fallen, and so claiming losses by selling bond funds could help you recoup at least a portion of your losses.
Finally, one extra reason to act quickly with tax-loss selling is that if you've held a stock for nearly a year, taking the loss while it qualifies as a short-term capital loss can save you more money. Short-term gains have a higher tax rate, so if you can use losses to offset those short-term gains, you'll save more. But if you wait until you've held a losing stock for more than a year, you'll have to use losses to offset long-term gains first, which don't provide as much in savings. For instance, on the stocks above, I mentioned returns since October -- those losses are short-term in nature now if you bought during that month, but they'll be long-term by the time most people think about tax-loss selling this coming November or December.
So even if you normally wouldn't think about taxes in summer, it's worth taking a look at your portfolio to identify potential tax-loss candidates. Doing it now could save you a bundle in the end.
Tax-loss selling is just one way you can try to tackle the tax increases that took effect at the beginning of 2013. To get more ideas on how to take control of your taxes and reduce your tax bill, read our brand-new special report, "How You Can Fight Back Against Higher Taxes." Inside, The Motley Fool's tax experts run through what to watch out for in doing your tax planning this year. With its concrete advice on how to cut taxes for decades to come, you won't want to miss out. Click here to get your copy today -- it's absolutely free.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.