| "Isn't life a series of images that change as they repeat themselves?" |
| -- Andy Warhol |
ITH LABOR DAY BEHIND US, VACATION season is rapidly drawing to a close. The passing of the seasons and memories of vacations past turned our attention to their relation to investing.
That's right, investing has these elements, too. For example, did you take a lot of snapshots on your vacation? They may not be worth hanging in the Louvre, but they're probably sufficient to capture the feel of your vacation. Oddly enough, many investors use a "snapshot" to track their portfolio. While it's a simple procedure, there's several major problems with it. Snapshot Investing explains the process and its shortcomings.
There are also investing "seasons". Yep, there are times during the year when it's better to buy or sell. The Investing Almanac has a list and description of some of these seasons. You may even find it more useful than looking in a traditional almanac for the phases of the moon.
Have you been doing any reflecting? We're open to new ideas -- well, some anyway. E-mail us.
All too often, we let our tax aversion rule our investment decisions. While we may take comfort in the fact we shorted the tax man, we ignore the fact that we've cheated ourselves. Obviously we don't set out to do this, we just end up doing it.
Like most common errors, there's some logic here - just misapplied Here's how it works. You periodically review your portfolio (that's good) by distinguishing winners from losers. The easiest way is to compare the current value to what you paid - if it's worth more, it's a winner, if not, it's a loser.
So far, so good, but just looking at this little "snapshot" of your portfolio can lead to some really bad decisions, especially when taxes are an issue. Why? Because there's a temptation to hold onto the "winners" and avoid paying taxes. Haven't you done that?
Of course you have, and there's nothing wrong with it as long as the winners continue to go up. But the decision whether to hold or sell a stock should be based on what you think it will do in the future, not what it did in the past or the tax ramifications of a sale.
Now, let's suppose you were smart (or lucky) enough to purchase $10,000 worth of Bombay on January 1, 1991. Let's also assume you're a snapshot investor, looking at your portfolio at the end of each year. The accompanying table shows what you'd see.
From 1991-1993 you'd have amassed some tremendous profits. While you might have been tempted to sell a little to capture some gain, you'd probably be deterred by the tax you'd have to pay. After all, if you just sold half the position in 1992 or 1993, your tax due would exceed the entire initial investment. You wouldn't want to do that, would you?
OK, so you hold on. By 1994, the Bombay's starting to come back -- and fast. Between December 1993 and December 1994, your profits have been cut by 2/3. But if you sell now, you'll still have to pay tax on the remaining gain that would cut further into your profits. A snapshot investor wouldn't want to do that.
The same reasoning would hold in each of the next three years despite the falling profits. Finally, in 1998, the unrealized gain starts heading back up. If you sold now, you'd owe more tax than in the previous several years, so as a snapshot investor you'd hold on.
If you're expecting to hold on until you die and then pass the stepped up basis to your heirs, this makes sense. Otherwise, it's quite paradoxical -- the only time a snapshot investor is willing to take a profit is when there is none. That's the only way to assure you don't pay any taxes.
If you're going to invest in stocks, you've got to realize you'll be incurring capital gains and paying taxes on them. If you aren't paying taxes on gains, you aren't making any money. Your decisions to buy and sell stocks should be based solely on your outlook for the stock's performance regardless of the tax consequences.
A picture may be worth a thousand words, but snapshot investing can end up costing thousands of dollars.
For example, you may not be able to foretell the exact day when winter's cold will arrive, but you can be fairly certain it will be in late November to early December. The calendar may show a particular date and time, but the first cold blast could occur well before or after that. Stock seasons are like that, too. You may not be able to pinpoint the exact date when one begins or ends, but you can have a pretty good idea of when they'll occur and how long they'll last.
So what are stock seasons? Well, they're certain times of the year when stocks show particular tendencies. Some of them are new, owing their existence to the increased level of institutional trading. Some are the results of the increased popularity of day trading while other have been around forever.
Here's a few of the most noticeable stock seasons:
In order to preclude this unfortunate occurrence, companies have started to announce "warnings" prior to the official earnings releases. These pre-announcements (read: earnings confessions) usually occur in the final four or five weeks of the quarter, when management realizes there's not enough time left to make up the anticipated shortfall.
This is usually a slow period for equity-related news, so negative pre-announcements can be a drag to the entire market. Often, when a company makes such an announcements, stocks in the same industry or entire sector are sold off, offering short-term buying opportunities. In general though, Earnings Confession Season is negative for the stock market.
Can you use these seasons to your advantage? Sure you can, but in most instances, you have to have a short-term investment horizon. Be prepared to trade in and out in a 3-6 month period.
Do these trading strategies always work? Of course not! If they did, everyone would use them so (ironically) no one could. Like those of the climate, investing seasons can be extremely fickle.
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"I started out with nothing. I still have most of it." -- Anonymous
ON'T YOU HATE PAYING TAXES? Of course you do, everybody does. Unfortunately, if you're going to make money investing, you have to pay some taxes along the way. If you're not paying taxes, you're not making profits.
logic. A prime example is what we call "snapshot investing". You've probably engaged in this, maybe even now.
Example: The Sun Sets on Bombay
To see the utter folly of this reasoning, let's look at an example. Back in the early 90s, Bombay Company was one of the hottest stocks around. As you probably know, Bombay is a retailer, selling
affordably priced furniture reproductions and accents. From 1991-1993, business was good, the stock was rising, and momentum investors were going along for the ride. In 1994, management attempted to expand the product line, but made some costly miscalculations. The momentum guys jumped out, and the stock plunged. It's languished ever since.
Annual Snapshot
DateMarket
Value
CostUnrealized
Gain12/31/90
$10,000
$10,000
- 12/31/90
$21,631
$10,000
$11.631 12/31/92
$71,413
$10,000
$61,413 12/31/93
$132,066
$10,000
$122,066 12/31/94
$44,022
$10,000
$34,022 12/31/95
$28,064
$10,000
$18,064 12/31/96
$21,460
$10,000
$11,460 12/31/97
$20,360
$10,000
$10,360 12/31/98
$24,212
$10,000
$14,212 The Sad Paradox
So when would you sell? Well if you're a snapshot investor, you would wait until your tax burden is minimized and this only occurs when you have no profit or a loss. In the Bombay example, you'd forego your 1993 profit of $122,000+ in favor of avoiding taxes. Each year, profits dwindled away, but the snapshot still showed there was a gain so taxes would still be owed on any sale. Unfortunately, snapshots aren't very helpful when gains are declining from period to period.
"To everything there is a season, and a time to every purpose under heaven." -- Ecclesiastes 3:1
LIKE THE WEATHER, STOCKS have seasons, too. In fact, their seasons have a lot in common with the climate.
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