Disclaimer: Forager can’t provide personal advice, please be aware the thoughts below are formed with no knowledge of your personal circumstances. The values ascribed to the shares of Woolworths and Austbrokers are arbitrary and do not reflect the view of Forager.
A dilemma often faced by long-term investors is when to dispose of your best performing shares, typically those with large, unrealised capital gains. It's the kind of problem you should dream of having, but the tax consequences can be huge so it's well worth thinking through.
The investing community often suggests 'don't sell too soon'. After all you don't want to give up any more of your gains to the tax office or brokers than you have to. Fair enough, but what if you are sitting on something fully priced when there are better investments around? Is there is a point where you should move on?
Yes there is. The approach we use at Forager is to ‘forget’ what you own and don’t own, and treat the sale decision just like a ‘buy in reverse’. Sound confusing? It’s best illustrated with an example.
Bob bought Woolworths shares for $10 many years ago, and they now trade at $33. Bob thinks the shares are worth $40. He is considering whether he should sell Woolworths shares and buy Austbrokers’ shares which trade at $10 but he estimates are worth $16. Bob will pay 19% capital gains tax and brokerage of 0.3% if he sells Woolworths. He’s reluctant to pay more tax than he needs to. What should he do?
Firstly, Bob should pretend he sold his Woolworths shares already. In which case he realises $28.55 after costs and taxes. Now Bob should consider whether he wants to reverse the sell decision, that is ‘buy’ Woolworths at $28.55, or instead purchase Austbrokers at $10.
If Bob’s view on values are correct, Austbrokers’ discount to value is 38% versus 29% for Woolworths. This means it makes clear sense to sell Woolworths, for less than fair value and despite the need to pay capital gains tax. The value on offer elsewhere is simply more compelling, and he has crystalised a capital gain that he was probably going to pay tax on eventually.
Obviously the real world is more complicated than our hypothetical one. The value of a stock is never known with precision. Different stocks have different risk profiles and complement the rest of your portfolio to varying degrees. Our experience is that you tend to know the stock you own better than the one you don't. But you have to think about all those issues with every buy and sell decision.
While no one loves making the tax office or their broker richer, sometimes it's the correct decision. Investors should look to maximise value after tax, rather than just minimise tax outright. If the boost to value exceeds your transactions costs, you should go for it.
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