By JACK HOUGH
There are 23 trading days left in 2011 -- plenty of time to sell losing stocks for tax purposes. But investors shouldn't wait, for two reasons.
First, selling late puts an investor in competition with many others who are doing the same thing. That could result in a lower price than they would otherwise get.
Some researchers believe the January Effect, where stocks that decline in a given year tend to outperform early in the following year, is caused by tax loss harvesting. Shares of poor performers sink lower than they otherwise would due to last-minute tax selling, the thinking goes, and then rise after year's end.
There's some dispute over whether the January Effect is as powerful today as it seemed in past decades, and many other factors will affect stock prices in coming months. But all else held equal, it can't help to wait and sell with the herd.
The second reason to sell now is that most investors hold losers too long, whatever the tax consequences. A basic human tendency called loss aversion makes investors want to ride out a paper loss as long as possible in hopes the stock will turn around, even though the economic benefits of that strategy are dubious.
Price momentum matters, after all. If anything, investors should sell losers early and hold winners as long as they can -- just the opposite of what studies show most do.
The S&P 500 is sitting about 5% below its starting point for the year, not including dividends, so plenty of investors have losses. The tax benefits available to them are generous: Losses can be used to offset gains. Tax rates for long-term gains are temporarily capped at 15% but short-term gains can be taxed up to the top marginal income tax rate, 35%.
Losses can also be used to offset ordinary income, but only $3,000 per year. Losses not used this year can be carried forward to future years.
Investors who sell must wait 30 days before re-buying the same security to avoid a so-called wash sale, which forfeits their tax breaks. They may buy a different security right away. Mutual fund holders can exploit the vast number of fund choices to avoid a wash sale -- by, for example, selling an S&P 500 index fund and buying a Russell 1000 one.
For stock investors, tax loss harvesting provides as good an opportunity as any to upgrade to better-performing holdings.
Ruby Tuesday (RT)
Instead, take the opportunity to reduce exposure to financials and stock up on financially strong firms in other sectors (see "AAA-Rated Companies With 3% Dividends"). You'll pay taxes on the extra dividend income you collect, but that's not such a bad problem to have, and the dividend tax rate is capped at 15% through 2012.