<<At a minimum we will pay 20% capital gains taxes at the Federal level. So the market pulls back 20%we are only even...>>
Remember the tax is only on the profit, while the decline is on your entire market position. Forgetting this can lead to overestimation of the tax penalty.
Example: Suppose you started 1999 with X in cash, which you then invested, and suppose you had a good 99, making 100% profit. So now, in Jan 00, you have 2X. You decide to sell, incurring taxes due in April 01 at the 20% rate. Assuming no other gains or losses, on April 15 01 you would have X + X - (.2)X = 1.8X.
On the other hand, if you're afraid of selling and hold on until April 15 01, and the market has declined by 20% in that time, you will then have .8 times 2X or 1.6X. Not only is this less than the 1.8X above, but you still have yet to pay taxes on the .6X profit. Doing so at the 20% rate would leave you with 1.48X.
If instead the tax bite is 40% for the early seller, he would only retain 1.6X. But that's still better than the 1.48X the later seller retains after taxes after a 20% decline, even if he only suffers a 20% tax rate. |
