Booking losses at the
right time forms the most important part of wealth management strategy.
Do you book profit or book loss?
You have bought the shares of ABC Ltd at a rate of
Rs.100 per share. The current market price is Rs.150 per share. Also you have
bought the shares of XYZ Ltd at a rate of Rs.200 and the current market price
is Rs 125.
Do you book profits by selling ABC or book losses by
selling XYZ.
Rule No.1: Never lose money. Rule No.2: Never forget
rule No.1: Warren Buffett
This quote from Warren Buffet is the essence of
selling loss-making investments as part of wealth management. However, to the
contrary, most of us tend to sell those investments that make us money and
prefer to hold on to those that are already making losses. It is just probably
a feeling that we could not have gone wrong and the investment would revive, or
on the other hand a feeling that we have been fooled and do not want to be
fooled again and do not want to take action.
What to do with loss making investments?
"It's not whether you're right or wrong that's
important, but how much money you make when you're right and how much you lose
when you're wrong" - George Soros
I recollected this saying when an investor told me
that he always invested in right investments at the right time. I acknowledged
his prudent nature, but felt that he and many other financially prudent persons
needed to know that they also required to regularly review their investments to
eliminate non-productive ones for productive and paying ones.
Wealth management is all about making money work best
for you.
George Soros's lessons of prudent wealth management
lie in not allowing your investment to depreciate (fall in value).This involves
being ready to leave your comfort zone and revise your investment decision with
the right attitude of being proud of the right investment and at the same time
not being disgraced or regretful in making revisions or corrections in
decisions already made.
Review your investments with the current outlook
Most of us make investments that are based on the
information available to us at a given point in time. But it is important to
know that with times the profitability or loss of an investment could change.
It definitely proves useful to review and revise our decisions when we find
that we are holding on to something that no one would buy or invest in now.
It is right that it is human to make mistakes, but
holding on to a mistake just for emotional reasons cannot be pardoned.
Subsequent events might alter the attractiveness of the investment.
Should we be possessive in our attachment to those
investments for which the outlook has changed now? So I would say that if you
need to create wealth and manage it, there is nothing wrong in being a fair
weather friend; investments have to work for you and not accomplishing this
goal means getting out of these investments for better avenues.
Do I need to book losses when the market is falling?
However I wish to be excused when I say it is not good
to sell when the prices on the whole have fallen down. However it is again
important to believe that poor stocks would surely be losing more than good
ones; fall in price just does not indicate a downturn, it is a combination of
various factors like production, sales and profits also; so poor stocks or
small companies may find it difficult to recoup even when we experience
favorable times in the market.
Again during the fall in the market it is common for
us to see that even good stocks may be available at a discount. I would say
such times are ideal to liquidate poor performing stocks that are not doing
well and purchase good stocks.
Why should you book loss?
Booking losses in poor performing investments has got
some advantages. So as to quit the poor performing investments, you are forced
to quit your ego and admit that you have made a wrong investment decision.
As you admit your mistake, you learn a lesson. As you
learn a lesson you do not take similar wrong investment decisions in the
future.
The advantage of booking losses is you move out of
poor performing investments and moving into better performing investments. So
you will be able to recover your losses faster.
How to Get Tax Gains from Your Losses in Shares
For the purpose of tax
computation of total income of an individual, all incomes are classified under
five heads, under the Income Tax Act: Salary, Income from House Property,
Income from Business or Profession, Capital Gains and Income from Other
Sources. The total income under all these five heads of income are added and
after allowing deductions the total income tax is calculated based on the tax
slabs.
However, tax laws allow setting off of losses against
gains in the same category, based on different criteria. If an income is
tax-exempt, it however cannot be adjusted against any loss from an income that
is taxable. For tax computation, profit or losses in shares are clubbed under
the head of capital gains.
If an investor has held shares for less than 12 months
from the date of buying, then the resulting loss on its transaction on stock
exchanges, if any, is termed as Short-Term Capital Loss (STCL). On the other
side, if an investor has held shares for more than 12 months, then the
resulting gain/loss is termed Long-Term Capital Gain/Loss.
This loss can be adjusted against the Short-Term
Capital Loss (STCG) or Long-Term Capital Gain (LTCG) from shares, if any, thus
lowering the tax outgo. Short-term capital gains from equities are taxed at 15
per cent.
If the short-term loss cannot be set off in the same
fiscal, then the balance can be carried forward to subsequent eight years. In
each of these, the said short-term losses can be set-off against short-term
capital gain (STCG) or long-term capital gain, if any.
To reduce outgo, many investors set off gains made
from equities in the fiscal against losses occurred in same year or previous
year. They book losses, if any, on existing holdings and then later repurchase
the stock to keep their holdings intact.
For example, an investor has already booked short-term
profit (by selling within 12 months) of Rs. 10,000 in some stocks. At the same
time, the investor is sitting on un-realized loss of Rs. 4,000 in some other
stocks.
In that case, the investor has to pay short-term
capital gains tax at 15 per cent on Rs.10,000 profit. To reduce short-term
capital gains tax liability, the investor can sell the stock on which he is
incurring Rs. 4,000 of losses. In that case, the investor's has to pay tax on
Rs. 6,000 (Rs. 10,000 - Rs. 4,000), not Rs. 10,000. To keep his holding intact,
the investor can later repurchase the stock.
However, long-term capital losses on shares can only
be set off against long-term capital gains, if any. Further, any long-term
capital losses that cannot be set off against long-term capital gains arising
in the same fiscal can be carried forward to subsequent eight years.
Disclaimer: "Investors are advised to make their
own assessment and counter checks before acting on the information. - Tax Rules
are subject to changes”
