Saturday, September 16, 2000

The Sophisticated Investor

Smart selling takes some sting out of dumb buying

By John Waggoner

        Admit it: Sometime at the start of this year, you bought a mutual fund. Not just any fund. No, you bought a fast fund. If this fund were a car, it would have come equipped with 12 cylinders, turbocharged, keyless ignition. You'd get a ticket just thinking about it.

        Unfortunately, your fund is now lying in a ditch somewhere with a broken axle. What should you do?

        Sell it — even if you like the fund or the market sector it invests in. You'll get a great tax break, and you can reinvest the money into a similar fund without getting pulled over by the Internal Revenue Service.

        Many people will claim that they didn't invest in high-flying funds back in January, February and March. Don't believe them. Investors poured $130 billion into stock mutual funds the first three months of 2000, ac cording to the Investment Company Institute, the funds' trade group. That's more than four times the amount they poured into stock funds the first quarter of 1999. So you're in good company.

        Investors put their money in the funds that fared well in 1999. For example, an esti mated $580 million poured into Firsthand Communications fund, a new team-managed fund headed by red-hot manager Kevin Landis. His best-known fund, Firsthand Technology Value, blasted to a 190 percent gain last year. The blazing Kinetics Internet fund soared 216 percent and was flooded with $217 million in new money.

        Unfortunately, the stock market correction began in March and smacked many of the most popular funds hard. Firsthand Communications has tumbled 17.6 percent since March 31; it's up 14.1 percent so far this year. Kinetics Internet hasn't been as fortunate: It's is down 32.9 percent since March 31 and 27.4 percent for the year.

        Most fund companies would tell you to hold your fund, preferably forever. Malarkey. Selling losers is one of your best moves, particularly if you're investing in a taxable account.

        For example, suppose you had invested $50,000 in the Grand Prix fund March 31. Grand Prix didn't quite make it around the last turn: It's down 19.5 percent since March 31, and your $50,000 is now $40,250. You have a $9,750 short-term capital loss.

        A capital loss is a wonderfully useful thing. Let's suppose you weren't a total goon this year. You sold a stock for a $4,000 long-term capital gain. You have a $1,000 short-term capital gain, too. You can:

        • Use your capital loss to offset capital gains. You'd first apply your short-term losses against your $1,000 short-term gain, which would otherwise be taxed at your regular income tax bracket. Then you can apply your short-term loss against your $4,000 long-term gain, which is taxed at a maximum 20 percent.

        • Deduct up to $3,000 of your additional losses from your 2000 federal income taxes this year.

        • Carry forward any excess losses to the next tax year. In this case, you'd have a $1,850 loss going into the 2001 tax year.

        If you've learned your lesson and have vowed to tone down your investing, fine. But if you like aggressive funds, don't worry. Just wait for 30 days to pass, and buy your fund back. If you don't wait at least 30 days, the IRS will deem your sale a “wash sale” and disallow your capital losses.

        But let's say that 30 days seems like an eternity. You don't want the gains in this particular part of the market to slip away. (You really haven't learned anything from this experience, have you?)

        So consider investing in an extremely similar fund. For example, Artisan International was extraordinarily popular the first three months of 2000. Lipper estimates that $2 billion poured into the fund. It's down 15.1 percent since March 31.

        But Master's Select International, a team-managed fund, has Artisan's manager, Mark Yockey, on the team. The past 12 months, the two funds' performance is tightly correlated. You could sell Artisan and buy Master's Select International, keep your capital loss deductions and remain fully invested in a very similar fund.

        No one likes taking losses — or admitting investment mistakes. But smart selling can take some of the sting out of dumb buying. And it's a lot easier than hammering dents out of a new sports car.


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