About two years ago a very public debate among the big boys began to play out. I am not participating in the debate, but it provides a great example of how investment decisions should be driven by valuation, not taxes. A little background.
Unless you were living under a rock the past few years, you know that this guy named Ackman is short Herbalife and another guy named Icahn, who incidentally doesn’t much care for Ackman, is long Herbalife.
Icahn owns a lot of Herbalife stock and his average price is around $36. Less than a year after Icahn’s investment, Herbalife’s stock climbed greater than 100%, exceeding $80 per share. That’s a 100% gain, not too shabby.
I have to assume he sold, paid short-term capital gains and walked away. Even at the top marginal rate of around 50% (and it most likely less than this), his return still would have been 50% in under a year. However, the tax advisor in you wants to suggest a great deal for Carl. Here is your suggestion: wait a little bit, so that Carl receives long-term capital gains and then his 50% after-tax return will instead be 80% return (assuming 20% long-term capital gains).
Great deal…right? Carl didn’t sell…[I am not implying that he didn’t sell because of taxes, but the end result and lesson is the same].
Fast forward to March 2015, let me check the stock price on Herbalife, roughly $42 (it was in the low 30s two weeks ago when I was thinking about this post). So, instead of a one year after-tax return of 50%, Carl now sits on a two-year after tax return of about 13.5%. Not only is his return much lower, but his money has been tied up in this investment for two years, instead of the less than one year time period it would have been if he had sold during the run-up.
This past year I owned a stock that received good news. The market, however, perceived this news as AMAZING and the stock ran up approximately 200%. I decided to sell. There were short-term capital gains involved. That was ok.
6 months later, the stock is still up, but now only 22% from my original purchase price.
If Mr. Market wants to give you sky high valuations on the upside, I don’t think it is wise to consider waiting for long-term capital gains treatment.