Rational Investing: Consider potential tax changes in election year

|tab|

Clark Davis is a 34-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company.|ret||ret||tab|

|ret||ret||tab|

Sure signs of spring: The Masters, dandelions (ugh!) and taxes. The most vexing? That's easy: taxes.|ret||ret||tab|

The different holding periods, dates of transactions and tax rates for long-term gains taken during 2003 are ridiculous. If the members of Congress ran their own lives as they run ours maybe we would have tax laws, health coverage and retirement benefits that make sense. But no-o-o-o! |ret||ret||tab|

At this point they have no power to eliminate the dandelions; however, I wouldn't bet against them eventually imposing their politically correct will on the members of Augusta National and insisting on opening membership to women. But I digress.|ret||ret||tab|

Let's talk about the tax situation. Not that there's anything we can do about the income tax code, which began in 1913 with 14 pages of law supporting a two-page tax form. (The instruction booklet for today's tax forms is larger than that!) Curious about its existing size? The complete Internal Revenue Code is more than 21 megabytes in length, and contains more than 3 million words. Printed 60 lines to the page; it would fill more than 6,000 letter-size pages. (Many of these pages were added by the oxymoronic Tax Simplification Act.) |ret||ret||tab|

There are approximately 700 separate sections of the tax code that apply to individuals. There are more than 1,500 separate provisions that apply to businesses.|ret||ret||tab|

So, we have to deal with an unwieldy, confusing and often contradictory set of rules, regulations and (worst of all) interpretations.|ret||ret||tab|

It's too late to do anything about last year's investment-related tax liability, so let's address what can be done to minimize this year's. Start with putting in your planner or on your calendar a note to review all your gains and losses at the end of the third quarter. That will give you ample time to complete before year-end any transactions that can be used to offset losses. |ret||ret||tab|

It is also a good time to meet with your CPA and investment professional to determine if there are any other tax-saving techniques that should be considered. It does not do any good to complain about your taxes to your accountant in April if you failed to work with him before the end of the previous year.|ret||ret||tab|

Keep a close eye on proposed tax changes and how they might affect your portfolio. Give serious thought to the "what ifs." What if Kerry becomes the next president? What if the Republicans lose control of Congress? What changes in the tax code might occur? For example, if you own long-held, low-tax-cost basis stocks and the capital gains rate is to be increased from the current 15 percent, those holdings should be considered sell candidates. If dividends were to return to being taxed as ordinary income, how would that impact the value of your higher-yielding equities?|ret||ret||tab|

Here's one that is not in the same "what if" category and is often not followed by even savvy investors. Do not let the tax tail wag the investment dog. A profit of any kind, even short term, is better than a loss regardless of your tax rate. Here's an example.|ret||ret||tab|

An investor taxed at a total rate (state and federal) of 40 percent buys Western Digital for $10.66 at the end of May 2003. By the end of October, he has a gain of 36 percent but doesn't sell because he wants to avoid paying taxes at the 40 percent rate on his short-term gain, which would lower his after-tax return to 21 percent. So he decides to hold it until it becomes a long-term gain (June 2004) in order to qualify for the more favorable 15 percent rate.|ret||ret||tab|

At the close of the market on March 26, Western Digital was at $10.54. Not even break-even. |ret||ret||tab|

But how, you might ask, does he know that it isn't going higher? Easy, if he had used the discipline we have discussed often of setting sell points based on factors such as PEG. (See my SBJ archived articles for a detailed explanation.) Even if he does not use a disciplined, sell-point method, what's wrong with a net 21 percent profit? Nothing, unless emotions set in and greed takes over. That's one reason the average investor has problems managing his own portfolio.|ret||ret||tab|

|ret||ret||tab|

Alert! Alert!|ret||ret||tab|

Business Week magazine's March 22nd issue has on the cover the headline, "Where Are The Jobs?" Our favorite contra-indicator (remember their "Death of Equities" cover at the bottom of the bear market?) has just given a huge boost to our prediction that job growth is about to take off disarming one of the liberals' battle points.|ret||ret||tab|

[[In-content Ad]]