Your goal as an investor is to assemble a portfolio that allows you to steadily build wealth over time. But on the road to building wealth, you might hit some snags. Specifically, you may end up having to sell a stock when it's down, thereby taking a hit on that investment.
To be clear, a lot of people's portfolios are down right now year to date due to general stock market turbulence. And that's not a very good reason to sell a stock.
But let's say there's a stock in your IRA or brokerage account that's been consistently losing value since you bought it. Let's also say that you've been following the company's financials and have reason to believe those shares will be worth even less money down the line. That's a good reason to take a loss rather than sit tight and ride things out.
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If that's the scenario you've landed in, try not to stress. Although investment losses can be frustrating and upsetting, they can also, in some ways, work to your benefit.
How to capitalize on an investment loss
Investment losses aren't ideal. But you can use them to offset capital gains in your portfolio in a non-tax-advantaged account.
Let's say you're sitting on a stock that's done remarkably well this year, even though the market, on a whole, has been iffy. You may be inclined to sell that stock while it's way up and walk away with a nice profit.
Normally, the IRS would be entitled to a share of that profit in the form of capital gains taxes. But if you're sitting on a capital loss, you might manage to reduce or wipe out that obligation entirely.
Let's say that by selling that winning stock today, you'd gain $5,000. If you have a $5,000 loss on another stock that you sell, you won't owe the IRS anything.
Now let's say you're only looking at a $2,000 gain in the scenario above. You can still use your full $5,000 loss to your advantage. That's because the IRS allows you to offset up to $3,000 of ordinary income with capital gains losses.
Capital gains losses can be carried forward to future tax years. Let's say you're looking at a $1,000 gain in this situation, not $2,000. If you use your $5,000 to offset that $1,000 plus $3,000 of ordinary income, you can carry the remaining $1,000 forward.
Dig deeper -- but don't beat yourself up
If you lost money on a stock this year, it's a good idea to see if you can figure out why. Maybe you didn't spend enough time digging into that company's financials. Or maybe that loss wasn't preventable -- things just declined at the company and it wasn't something you could've predicted.
It's a good idea to get to the bottom of why you're sitting on a loss to potentially avoid making the same mistake again. But don't give yourself too difficult a time. It's pretty rare for investors to get every single decision they make right. And harping on a loss might make you lose confidence in your ability to handpick stocks, so there's no sense in putting yourself through that.
