Another way to deal with a falling stock market is to write covered call options, selling somebody the right to buy your holdings, presumably appreciated, at a specified price. This produces income from the premium received, protects your profit and, if the expiration date of the call is next year, lets you defer the gain.
Selling calls seems a better bear-market strategy these days than buying puts, which have become quite expensive amid the market turmoil, said Gordon B. Fowler Jr., chief investment officer at Glenmede Trust in Philadelphia. “You want to be selling rather than buying insurance right now,” he said.
Of course, the November elections will bear watching, analysts said, because of the tax cuts for capital gains and dividends that expire at the end of 2010; significant increases could be in the works as early as next year.
Because the market is always looking ahead, impending tax changes will likely affect prices. Mr. Schwarz suggested, “You want to make your move with respect to your stocks before enough of the public begins to factor that in.”
More specifically, this may mean taking gains before taxes go up or putting less emphasis on stocks with hefty dividends. “There is a risk to higher-yielding stocks,” which would presumably become less appealing if the maximum 15 percent tax on dividends were raised, Mr. Fowler said.
In case you want to sell only a portion of a profitable block of shares, it is generally advisable to sell the highest-cost ones first, though in some cases you would fare better by selling less costly shares if they qualify for long-term capital gains treatment.
Losing stocks held for a short period, however, are to be unloaded first; short-term losses are generally most valuable because they can offset short-term gains that would otherwise be taxed as ordinary income.
Up to $3,000 a year of all capital losses can offset ordinary income, even though the tax code sets no limit on how much gain is subject to tax. Losses of more than $3,000, however, can be carried forward indefinitely.
If you decide to take tax losses but still like the investment, you need to pay attention to the timing of your trades. You are forbidden under the “wash sale” rules from buying the same shares within 30 days before selling at a loss as well as rebuying them within 30 days after such a sale.
“Be careful if you’re harvesting losses at the same time” you go hunting for bargains, counseled Mr. Ochsenschlager of the accountants group.
If the stock slide continues, the perennial late-year trap into which many mutual fund investors fall — buying shares just before a capital gains distribution on which taxes are due on early-year gains — may be especially pernicious this year.
Falling prices may prompt a fund’s investors to redeem shares, perhaps forcing the fund’s managers to sell shares to meet the withdrawals.
“Frequently they end up liquidating stocks in which there is a gain,” Mr. Schwarz said, “so you could find yourself in a situation where the value of your holdings falls precipitously and at the same time you’re going to get a 1099 showing significant gains distributions.”
AND if you are among the many people who have been tempted to invest in hedge funds because they have lowered their investment minimums, you should recognize that they can prove a tax and paperwork headache, Mr. Rosica said.
Hedge funds tend to trade even more actively than mutual funds and with less regard for taxes while paying out relatively little cash, he noted, and it can be many months before the fund’s tax forms are delivered to investors, delaying their ability to file returns.
Hedge funds “sometimes have challenging tax ramifications,” Mr. Rosica said. “Know what you’re getting into.”