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Sell Your Losers!

January 18, 2008

Warren Boroson

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Buying and holding is supposed to be the best investment strategy. That’s what Warren Buffett does, right? His favorite holding period is forever? Actually, he quickly sells stocks that have disappointed him (remember that accursed airline stock?), and regrets that he didn’t unload a lot of overpriced stuff back in 1999. Right now, in fact, is a good time for everyone to consider selling. To sell (a) big losers in (b) taxable accounts.

I know, I know, all this is probably familiar to you. But when I tell people to sell their losers in taxable accounts, they look at me as if I were urging them to commit treason. And I’m not just talking about selling bad stocks. I’m talking about losers even if they are good stocks.

Why NOT sell good stocks now? Big losers in taxable accounts? Let’s look at the arguments.

1. The stocks are good companies and they will rebound big-time.

2. You will be contributing to the sell-off, causing more panic, delaying a market rebound.

3. What kind of a rat are you? Selling a good stock? Only cowards and back-stabbers turn on their friends when they are down. You’d probably mug your mother!

4. Besides, you’re taking money away from Uncle Sam – money he could use for schools, bridges, food stamps, Medicaid, and weapons of mass destruction. Finally,

5. Like me, you simply don’t have any big losers in taxable accounts.

Ok, I lied. I do have a loser—something I bought a few months ago. One swell mutual fund. I know the guys who run it. Smart, splendid fellows. Screw them. It gets defenestrated.

Why SELL losers now?

1. Because you may have a BIG loss—and you’ll get a big tax deduction. Easily compensating you for any commissions you pay.

2. Because you can buy something substantially similar—not identical—and be back almost where you started. Eat your cake and still have it. The SSNI security should have plummeted in line with the security you sold and should rebound when it rebounds. (A drawback: When security B rebounds and you eventually sell, you’ll have high capital-gains taxes to pay—because you bought it low.)

Of course, you can wait 30 days and re-buy the security. Except…good things can happen in 30 days. Besides which, I’ve been told on good authority that nobody, nobody at all, buys back a loser after 30 days.

Jan. 1: “I’ll re-buy that wonderful stock.”

Feb. 1: “Don’t talk to me about that dirty dog!” (If you buy back a losing security within 31 days of selling it, you cannot deduct the loss. The so-called wash-sale rule.)

Or you could double up. By buy the same number of shares; wait 30 days; sell the original shares for a loss; and wind up with your original holding—and a tax deduction. Problem here is: For 30 days, you’ve got twice the exposure to a disappointing stock.

***

Replacing your loser with a similar security has its dangers, too. Just as there are no true synonyms, no two securities are identical. Actually, it’s not that simple. Can you sell a losing index fund (say) and buy another index fund without breaking the wash-sale rule? I’m not sure. But you don’t have to choose a “similar” security. Just a security that seems equally good.

I can produce one more reason why people should sell their losers. Loss-aversion. People absolutely hate to sell their losers. We hate losers twice a much as we enjoy winners.

I once asked Richard Thaler, the behavioral economist, why people are so averse to selling their losers. His answer: It’s an inheritance from the days we lived in caves, when any loss at all—food, water, shelter, fire--threatened our very lives.

In other words, people hold on to their losers for irrational reasons.

In short: You know the folk wisdom about eating possibly tainted food?

“When in doubt, throw it out.”

Same goes for losing securities in taxable accounts. Throw them out.

Especially when they can bless you with tax deductions.

About the author:

Warren Boroson
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 2.9/5 (21 votes)

Comments

madbulk
Madbulk - 6 years ago
totally, baby. thanks for reminding me... honestly, I've always tried to tell friends the same thing, but I don't necessarily think so clearly in mid-January. But now seems like a very rational time. Today in fact. C is outta here. WaMu or similar, here I come, perhaps.

Nah, I'll just buy google. :)
buffetteer17
Buffetteer17 premium member - 6 years ago
All my losers but one look to me like long term winners. That one was Delta Finance. It is amazing what a declaration of bankruptcy can do to a stock's price. I sold out, then sold a winner to match the loss with a gain, then bought back the winner.
kfh227
Kfh227 premium member - 6 years ago
I own 5 financial stocks. Some like USB are doing fine (OK, only USB). Others have dropped.

The thing is, if I sell BAC, what would I replace it with? In my opinion, I view BAC as a wonderful company. So I'd have to sell BAC and then find an even more depressed fianncial stock whcih is more wonderful than BAC.

I'd love to load up on USB, but it hasn't fallen enough to be considered a BAC replacement.

To the poster that is thinking about buying WM, don't. It's not a wonderful company. Go look at BBT. That actually might be my BAC replacement.
buffetteer17
Buffetteer17 premium member - 6 years ago
Maybe BAC is being hit for their CFC deal? BTW, I just checked the prices.

BAC 35.97, CFC 4.96. Deal exchanges 0.1822 BAC shares per CFC share. That makes the buyout price 35.97 x 0.1822 = 6.55. That is a premium of 32% on CFC. Another way of looking at this is that you can buy BAC shares indirectly at a discount of 24% via CFC shares. Sounds like the market expects the deal to fall through, be modified, or take so long that the 32% profit is not worth waiting for.

So your answer about what to do with BAC is sell x shares of BAC and buy x/0.1822 shares of CFC. I never thought I'd be recommending CFC, but strange days are here again.
queenofmay
Queenofmay - 6 years ago
It might be easier to harvest losses with mutual funds, where you have a goodly number of securities snd you can compare numbers. With individual stocks, a problem may be that you know stock A, which you own, far better than stock B, a similar stock, which you don't own. But you don't have to buy a more wonderful or more depressed security: Just one that's very similar.
madbulk
Madbulk - 6 years ago
kfh227 Wrote:

-------------------------------------------------------

> I own 5 financial stocks. Some like USB are doing

> fine (OK, only USB). Others have dropped.

>

> The thing is, if I sell BAC, what would I replace

> it with? In my opinion, I view BAC as a wonderful

> company. So I'd have to sell BAC and then find an

> even more depressed fianncial stock whcih is more

> wonderful than BAC.

>

> I'd love to load up on USB, but it hasn't fallen

> enough to be considered a BAC replacement.

>

> To the poster that is thinking about buying WM,

> don't. It's not a wonderful company. Go look at

> BBT. That actually might be my BAC replacement.

Well, no... you don't have to find one that's even more depressed than your BofA -- just one that is similarly so. That's kinda the point. You can think your BofA pick was a great one and still make the argument that it could now be sold. And I was being glib when I named WaMu. I could've said almost anything -- Wells Fargo? I would've said BofA instinctively in fact were it not for the potential CFC timebomb. And that caution was just specific to posting in a forum -- even this great one -- but then you jumped on my WaMu instead. :)

And that's still probably the play, you're right -- cfc is a known and it's priced in and while it can certainly go lower right now there's practically zero doubt it's a good investment here.

Sell it anyway. Buy my C and I'll buy your BAC, and we'll both be better off.

madbulk
Madbulk - 6 years ago
bump!
mjtaylor123
Mjtaylor123 - 6 years ago
We all make mistakes and yes there is no reason to hold on to a loser, but lets be careful in how we define a loser.

We all know that the market is a roller coaster ride, but just because a stock has been beaten down does not make it a dog.

In addition, Warren Buffet does not sell stocks when they depreciate in price on the market rather he chooses to sell when the Business Fundamentals of the company are no longer as favorable as they once were.

I agree even the great Buffet has made several mistakes.

For example, I remember when he dumped all his shares in McDonald's in the late nineties because he decided that they no longer held the competitive advantage that enabled them to enjoy such high profit margins. Well, Mr. Buffet you were wrong as wrong can be. However, Dollar Cost Averaging is a sure way to beat this market when the Business Fundamentals are still favorable.

Let us take a look at Bill Miller's move into Amazon at $90 a share and all his subsequent purchases of the same stock until it reached like $5 dollars or something. His average cost per share came to around the mid twenties and the stock sky rocketed well beyond this. This my friend is what makes legends.

Don't get discouraged because your stock is down, only get discouraged when their cash flow is no longer favorable because after all it is king...cash that is.
alanb9
Alanb9 premium member - 6 years ago
the author was also incorrect in implying the "airline stock" was sold at a loss. It was not. Not only was it sold for a nice capital gain (convertable preferred which was called by USAir and converted, then sold those 3,830,538 shares) of many (40-50) millions profit, but he also collected about 90 million in dividends while he held the preferred, giving him a better than 30% return on his purchase. On an annualized basis, his return was less, but in no way did he lose money.

(edited for added details)

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