If You're Gonna Sell, Sell Now

Thinking about dumping some of your losing stocks? You might do better selling them now than waiting until the end of the year.

The one silver lining from losses in your portfolio is that you can use them to get tax benefits. By selling stock at a loss, you can use the resulting capital losses to offset gains in other stocks. In addition, you can use up to $3,000 of your losses against other types of ordinary income, including interest income and even your regular paychecks.

Because this year has been such a bad one for stocks, however, tax-loss selling will be on everyone's mind toward the end of the year. Just take a look at some of the losses among the most widely held stocks:

Source: The Wall Street Journal.

You can expect to see both mutual funds and individual investors use tax-loss selling to try to get at least something out of these and other losing positions they own. While funds generally need to take any tax losses by Oct. 31, you have until the end of the year to sell.

Several studies have looked at tax-loss selling and its effect on seasonal market phenomena, such as the Santa Claus post-Christmas rally and the January Effect. Although these events don't happen every single year, the effects do appear to be statistically significant.

Beat the crowd
First, what you need to do is figure out what your own tax situation will look like this year. If you know that you're going to want to use tax losses to offset gains or other income, then timing is essential. If you wait until the last few months of the year to sell, then you'll be just one of many shareholders in exactly the same position -- and that mass of selling pressure could well push your shares down even further, meaning you'll get less when you do decide to sell.

On the other hand, if you sell to lock in capital losses now, you can beat the rush of other investors who haven't even started thinking about tax-loss selling yet. You might well get a better price now than you'll get if you wait.

Wait to buy
If you're looking to buy some beaten-down shares, tax-loss selling leads you to a different conclusion. Instead of beating the crowd and buying now, it might well pay to wait until later in the year, when tax-loss selling could well push share prices even lower.

As with any other market-timing strategy, timing your sales and purchases around tax-loss selling isn't perfect. Obviously, tax selling pressure isn't the only thing that makes stock prices move. If the economy recovers strongly between now and the end of the year, then you might not benefit from waiting. Last year is a good example: After selling off sharply in both March and August, the S&P 500 was much higher for much of November and December.

Taxes shouldn't be the only thing you consider when deciding whether to sell a stock. But if taking tax losses will help ease the impact of falling share prices, then knowing in advance that millions of other investors will be trying to do the same thing later this year could give you a decisive edge.

For more on how taxes affect your investing, read:

• Our one-minute guide to taxes for investors.
• How taxes are just one of the costs of active investing.
• Why good tax planning takes year-round effort.