QUESTION:
My financial planner / mega company broker has complete control over my portfolio. I notice that I have a lot of short-term losses. Should I be concerned? My overall gain is usually positive.
ANSWER:
Sometimes it is a good idea to offset gains with losses. It is an investment tax strategy. If you have a lot of gains from sales of profitable companies and looks like a bad capital gain year - meaning you will have lots of tax to pay, then selling off some losers to offset gains may be a fine tax strategy.
On the other hand…
(and this happens more than not)
If you notice that your portfolio has pages and pages of short-term transactions, and they occur regularly throughout the year, and when compared to your long-term sales the short-term are overwhelming, it may be time to re-evaluate your plan.
Short-term trading as a strategy is flawed
An investment strategy of continually trading short-term (less than a year) is a bad strategy. First, if you are good at it and have gains, you will pay ordinary income tax on the profits, as opposed to significantly reduced long-term tax rates. Secondly, it is a losers game because most lose doing it, so a strategy like that will likely be unsuccessful.
So, even if your broker is one of the very few who are consistently good at it, it is a bad strategy tax-wise, unless it is in contained within a tax deferred retirement plan where no tax is due upon profitable sale.
Strategy may be self-serving to the broker
If your broker has a contract which enables him to earn commissions on every sale in your account, and he trades often short-term, he might be doing it for himself and not for you. Note the total gross sales short term, (should be a total on your year end tax statement) and see if you can determine how much money your broker made on your account while trading short-term. Then take a look at your gain or loss from just those short-term sales. My guess it is a loss because most short-term traders lose – well the client loses, the broker wins.
Is he offessting his losses with your gains?
Sometimes your broker just might sell off some long-term holdings for profitable gains to OFFSET HIS SHORT TERM LOSSES – to keep you in the dark about what his intentions really are – which may be to generate a lot of commissionable sales from your portfolio. He would, no doubt, prefer that you make money too, but if he is the only one making money, at least half of you are happy. If you discover this, you need to think about changing something.
Some have come to call short-term trading losses "Tax Harvesting". The term is supposed to mean to the client an advanced tax planning technique that will save thousands of dollars in tax liability. The reality here is that it does save tax because a short-term loss is a real loss and a reduction to portfolio value. A better term for this would be "Lets throw some money away so taxes will be less" strategy. Better to make $100,000 in long term capital gain and pay $20,000 in tax, than to offset that $100,000 gain with $100,000 of losses to pay no tax. Result to the investor is $80K one way, and zero the other. This is easy math.
Investment policy should be clear
An investment strategy must consider taxation. If it results in winning, you want to pay the least tax possible. A short-term strategy is a losers game. Whether it be to offset gains, or to actually make money because if you are successful short-term, you will pay the highest tax, if not you suffer portfolio loss. It is strategy that has proven far more likely to lose. If you have a financial planner / broker managing an account for you, clarify your strategy. Set an investment strategy with the objective of trying to net more money to you within your personal temperament, regardless of taxation. If that means you pay more tax because you do well, so be it.
It is not complicated. If you make money after tax, good. If not, not good.