Of course that's ridiculous, but isn't it about the same as the financial community's "Conventional Wisdom" (CW) for year-end tax planning? What about the long-term nature of investing, or the merits of that investment they felt so strongly about in July? What are their motivations, and what discipline thought up these strategies in the first place?
Clearly there are many questions that require answers, but as investors, it should be crystal clear that the object of the investment exercise is to make money... just as much as possible, quickly, legally, and within a low risk environment. The faster it comes in, the more effectively it can be compounded. Otherwise, wouldn't the "CW" be to find as many downers as uppers so that there are no tax consequences? Wouldn't Zero Taxable Gain Investing be the only "smart" investment strategy? A December, 2004 New York Times Money Section article actually suggested that Investment Professionals had an obligation to lose money for clients in order to reduce the tax burden.
Your Financial Professional's perspective may produce smart tax advice but only professional investors (not accountants, attorneys, stockbrokers, financial planners, advisors in general) should be called upon for acceptable investment advice. CPAs may look smarter if you have a lower tax liability, but many of them go too far with a calendar year focus that ignores the realities of an emotional and cyclical investment environment. Take last year's Merck for example. It has nearly doubled in Market Value since you were told to sell it last November... who'da thunk it! Why didn't you buy more (of this and many other high quality losers) instead of selling? Fortunately, not all professionals are into losing money. In fact, in nearly thirty years of dealing with hundreds of Accountants and other advisors, not even a handful have suggested that clients should take losses on fundamentally sound securities, Equity or Fixed Income. Just think if you had taken your dot.com profits in ?99, purchased the downtrodden profit making companies of the time, and paid the ugly taxes. The value companies didn't crash. They've rallied for nearly seven years!
The key issue in considering a capital loss is the economic viability of the investment... not your tax situation! A key element of The Working Capital Model (for investment portfolio management) is to eliminate the weakest security in a portfolio every time the Market Value of the portfolio establishes a significantly new "All Time High" profit level (an ATH). My definitions may be different than those you are used to: (1) Profit = Total Market Value - Net Portfolio Investment, (2) A "weak" security is a stock that is no longer rated Investment Grade by S & P, or no longer traded on the NYSE, or no longer dividend paying, or no longer profitable. Income securities whose payout has fallen to way below average (or risen to an unsustainable level) could also be culled at an ATH. Securities that have fallen considerably in Market Value for no apparent reason (other than recent news or changing interest rate expectations) are referred to lovingly as "Investment Opportunities". This is what you look for while trying to reinvest your profits... like last year's MRK. By the way, switching from the strong asset class to the weaker one as a "hedging strategy" or vice versa (as a greed motivated speculation) is simply an attempt at "market timing", not a "sophisticated" or "savvy" adjustment to your asset allocation. Asset Allocation is always a function of personal factors and never a function of asset class (Equities and Income Generators) directional speculation.
So what happens if a new portfolio ATH is achieved in February or August instead of in November or December? (Note that the financial community only preaches tax loss strategies during the last calendar quarter.) Should you unload all the weak issues at the same time, even those purchased just a few months ago? Management of your portfolio requires the disciplined application of consistent rules and guidelines, and every manager will develop his or her own style. But in a high quality, properly diversified, income generating portfolio, (1) the number of weak issues will generally be small and (2) the probability of escaping with only a minimal loss very real. Keep in mind two basic investment axioms: There is no such thing as a bad profit, regardless of the tax implications; and no matter how you may rationalize, there's no such thing as a good loss. So, sure, if a loss should be taken due to an ATH in February, bite the bullet on the one security (only one) with the declining fundamentals (A Merrill Lynch/CNN/CFP opinion is not a fundamental.) If there are none, good job!
Profits are the holy grail of investing. Few people will admit just how infrequently they have experienced them or, conversely, just how frequently they have watched them disappear beneath the waves of a correction. (Like gamblers retuning from Vegas... no one ever seems to lose!) Similarly, most financial professionals will counsel their charges to let their profits run, particularly around year-end. Surely, speaketh the CW prophets, these profits will hang around until next year, thus deferring those terrible taxes! (Worked real well at year-end ?99, you'll recall.) Don't think for a moment that anyone knows what will happen this time around the rally pole, particularly in those ridiculously priced ETFs, which are put together with the same kind of spit and duct tape used for the dot.coms. Always take your profits too soon, because you can't get poor that way!
First thing Monday morning I'm going to: (1) Call my accountant to tell him that I'm going to help him reduce his tax burden by not paying him, (2) continue to view the Investment process in cyclical rather than calendar terms, (3) limit my tax liability by how I invest, not by taking unnecessary losses, (4) continue to make as much money as possible, as quickly and safely as possible, and (5) contact the media, my political representatives, and anyone else I can think of that will help in the fight to abolish the taxation of all investment and retirement income.
Years ago, I was a limited partner at Bear Stearns and Company in New York City. Once a year, we would have a partner's meeting, and I would attend as a matter of course. Now keep in mind that we were a trading firm, also a brokerage firm. Back then we didn't do nearly the amount of investment banking that is done by some of the majors such as Goldman, Merrill, and Lehman Brothers at the time.
What was most interesting however is that we always referred to ourselves as "The Bank". It's a strange term when you consider that we were never licensed as a bank by the appropriate federal agencies. Nevertheless, on Wall Street when people were talking about their own specific firms, they always internally talked about "The Bank".
The reason for this term is quite simple and appropriate. Years ago, if you wanted to know how much money a brokerage firm made all you had to do was calculate interest earned versus interest expense, and you basically had the bottom line, give or take a bit on a pretax basis. When I was s Senior Accountant with Arthur Andersen in the early 1970's, this calculation was always appropriate, and we dominated banking and finance type companies at that time.
Recently after all these decades it looks like the same technique applies today that applied back then. Most individuals and institutions are still not making the interest they should be making, on the funds they have deposited with brokerage firms. They need to keep a better eye on their funds. The whole issue is the concept of IDLE CASH, and what is being done with it. Back in the late 70's, Merrill Lynch led the industry with the development of what they called the CMA account which stood for Cash Management Account.
The objective was to go up against the banks both commercial, as well as savings and loan and fight for the cash. What the brokerage firms are doing now is sweeping your idle cash from your accounts on a daily basis and paying you interest on that dollar amount. What are the brokerage firms paying? The answer is probably as little as they possibly can. Recently I saw rates on the order of 1.5%.
What happens is that at the end of the day, the firm checks to see what idle cash is available in your account. It then sweeps the cash and pays you 1.5% on the balance or less. Meanwhile the firm acting like a bank will reinvest your cash over night in its own firm account at a much higher rate. Do these numbers amount to anything?
Would you believe that last year in 2006 Merrill Lynch must have made net, net $2 billion for its own account after paying out lesser amounts in interest to its customers on their idle cash balances? That's right; they made $2 billion after expenses but before taxes. Is this any way to run a firm? You bet it is. The $2 billion was up from $1.3 billion two years before that. This mean's the firm is getting better at sweeping the balances, and they are sweeping bigger balances.
Morgan Stanley started getting into the act last year, and Smith Barney which is owned by Citigroup got into the game late by starting up last September with the same technique. When Merrill was quizzed about the practice, they came back and said that the brokers at the firm are encouraged by the firm to discuss "higher-interest options" in order to "meet specific client demands". Now I own a brokerage firm, and have been in the business for 30 plus years, my answer to that is "SURE".
The master of this game is Charles Schwab, the discount brokerage house. They were using this technique years before anyone else. Merrill apparently took it from them. Today if you study Schwab's financials closely, there is no question that they make more money from sweeping the idle cash from their client's accounts, plus margin interest than they do from brokerage commissions.
Brokerage firms also pay different interest rates on these idle cash balances depending upon the actual balance. The small guy gets hurt, as he always does by having less money to deal with. Balances below a $100,000 usually get the lowest rate which is probably about 1.25% at the moment. The big boys who have over a $1,000,000 sitting in the account can easily negotiate a higher rate by simply picking up a telephone. What the brokerage firm counts on is not getting that phone call.
Since most people with brokerage accounts are always transacting business by buying and selling securities, they are not consciously aware of their idle cash balances all the time. They are thinking about gains and losses, not interest. This is a mistake, because if you are not watching your money, who's watching it. The guy in charge of sweeping your account, is he watching it? You bet he is, but it's not your interest he has at heart. His year end bonus is completely dependent upon how much he sweeps, and how little he has to pay you for your own money.
Forget about reading the small print in your agreements with the investment companies. They use language that requires a lawyer to interpret. That's why the agreements are written by lawyers. The agreements will tell you that the accounts are "tiered". This means the larger the balance, the more interest you will get. Now how are you supposed to know that?
Wachovia which owns the old Prudential broker network waits until the fourth paragraph of their customer agreement to tell you that Wachovia "may seek to pay as low a rate as possible." This reminds me of the time that I was talking to a General Motors engineer about how much the jack cost in the trunk. His answer at the time was a"50 cents". I said you got to be kidding, are you telling me that my life is dependent upon a 50 cent jack when I get a flat tire in the middle of a winter night. His answer was "Yes, 50 cents is what we pay." As I walked away, he yelled, "Do you want to know why we only pay 50 cents for that jack." I said sure, why? He said, "Because we can't get one for a quarter." Be careful what you do with your cash, who's calling the shots on it.
Both Steve Selengut & Richard Stoyeck are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Steve Selengut has sinced written about articles on various topics from Tax, Social Security Information and Stock Market Crash. Steve Selenguthttp://www.sancoservices.com http://www.valuestockbuylistprogram.comAuthor of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy". Steve Selengut's top article generates over 14800 views. to your Favourites.
Richard Stoyeck has sinced written about articles on various topics from Politics, Finances and Foreclosure Help. Richard Stoyeck’s background includes being a limited partner at Bear Stearns, Senior VP at Lehman Brothers, Kuhn Loeb, Arthur Andersen, and KPMG. Educated at Pace University, NYU, and Harvard University, today he runs Rockefeller Capital Partners a. Richard Stoyeck's top article generates over 22200 views. to your Favourites.