Dump Your Losing Stocks Now!

For the past six months, the market rally has given most investors a break from thinking much about losing stocks. Yet you may well still have some stocks in your portfolio with losses -- and if you do, you might want to think about selling them sooner, rather than later.

It's never too early
It might seem silly to start thinking about income taxes in September, but it can be a smart move. In fact, by taking action before it even occurs to most people, you can beat the rush and potentially reap some added benefits.

If you own stocks that have dropped in value since you bought them, there's a way to earn back at least some of what you've lost. When you sell those stocks at a loss, you're allowed to take the resulting capital losses and apply them against any capital gains you have on other investments. If you have more losses than gains, then you can apply up to $3,000 of those losses against other income, such as wages and interest and dividend income.

With the rebound we've seen over the past six months, 2009 doesn't look like it'll repeat the experience most people suffered with tax losses last year. But there are still quite a few stocks that haven't seen their shares bounce back so far this year:

Source: Morningstar. As of Sept. 28.

While most investors have until Dec. 31 to sell losing shares for tax-loss purposes, mutual funds have an earlier deadline. Generally, funds need to act by Oct. 31 to get losses into their fiscal year.

That means that if you own shares of these or other losing stocks, you can expect funds that also own shares to start selling them in the coming weeks. That could put downward pressure on share prices.

What to do if you're selling
If you want to use tax losses against capital gains or other income, you might prefer to lock in those losses now by selling. By waiting until November or December, you'll just be one of the crowd. And with everyone trying to dump their shares at the same time, the selling pressure you create could push share values down even more, translating into less money when you finally get around to selling.

Conversely, by selling now, you'll not only beat the individual investors, but also some mutual fund managers as well. That might well give you a better price than you'd get by waiting.

But what if you like those beaten-down stocks?
On the other hand, some investors like to look for value among stocks that have been recent losers. If you're one of them, then waiting for a better deal may pay off if tax-related selling pushes share prices down.

The danger in using either of these strategies is that stocks move for a wide variety of reasons. Tax-loss selling isn't the only factor influencing share prices, and if you sell now, you might miss out on a subsequent rally that would have helped you earn back most or all of your losses. If you wait to buy until later, you could miss out on a bargain if the rally continues.

Still, if you foresee having a big tax bill come next April, and you want to take steps to reduce it, now's a good time to start thinking about selling any losing stocks you still have in your portfolio. Taxes shouldn't be the only reason you sell, but if you're going to dump those shares anyway, taking advantage of other investors with less foresight could get you a much better deal.