Happy Diwali folks! The festival of lights is among us. Let the kids enjoy their crackers and have their sweets. And be safe! All of us at Capitalmind wish you a wonderful year ahead.
In this quick note, we’re going to see an interesting strategy by Bond Baba – “Loss Harvesting”.
You don’t want to lose money on Diwali. It’s bad manners. Yet, losing money is a good thing. Because you get it out of your system. If you’ve bought a stock at a high value and it has fallen since, you technically have a loss. But you refuse to recognise that loss because, hey, you haven’t sold it yet!
But we want to tell you that this Diwali, even booking that loss could be a good thing.
If you’ve held the share for less than a year, you should sell the share. No, seriously. Just sell it. Get rid of it, during the Mahurat Trading session on Sunday, between 6:30pm and 7:30 pm. Breathe deeply first, taking care to not inhale toxic cracker fumes (we encourage you to do this at home rather than on your mobile). And then:
• Find the shares that you would’ve liked to continue holding for at least a year, but are at a lower price than when you bought them.
• Select only those shares that have been bought less than a year ago
• Sell all of the shares. Don’t even leave one.
And enjoy the weekend.
Why? I like those companies!
Of course you do. That’s why you are going to buy them back on Tuesday.
You’re going to buy them back on Tuesday. Monday’s a holiday so it’s not a trick thing. Buy the same quantity.
Now, you continue to own those shares. But you suddenly have something as a Diwali Gift: “Short Term Capital Losses“. It’s a gift because these losses can offset profits.
You have just harvested Tax losses.
The awesome thing is: you still own the same shares. But you have these losses that can increase your gains elsewhere.
Tell me more.
Bond Baba likes bonds. He keeps telling you to buy bonds that have short-term capital gains. Like SRTRANSFIN-NF. Or like the Muthoot bonds we started with. The idea is that you buy a bond and sell it at a profit, instead of waiting for interest.
This gives you “Capital Gain“. You think of it as – I bought something at Rs. 1,000 and I sold it at Rs. 1,100. I made 10% (btw, the SRTRANSFIN bonds have seen 12% and higher).
Then someone tells you: Listen, these are bonds, okay? You have short term gains of Rs. 100. You put that into your taxable income. Then you pay Rs. 30 as tax. (30% if you’re making more than Rs. 10 lakh in income from elsewhere). Then you’re left with Rs. 70. So what you make is 7%. Not 10%. Ha!
But it’s your turn to say Ha!
Because the Rs. 100 you made? You can offset it by that other share you bought at Rs. 1400 last month which has now fallen to Rs. 1300. Sell one share, take a Rs. 100 loss, offset your capital gain, and buy the share back again.
You still own that share.
Your 10% gain is now back to 10% by this little piece of magic! You successfully and legally avoided taxes. Congratulations.
Since you intend to hold for the longer term, you now continue to own the share but at a lower purchase price. But that lower purchase price does not mean higher taxes when you sell later. After a year of holding, the gains have zero long term capital gains taxes anyhow, so you won’t pay any more taxes when you eventually sell.
What’s The Finer Print?
Tax Loss Harvesting is easy and all it costs is the brokerage. Remember, though, that you shouldn’t sell shares bought more than a year ago – they cannot be used to offset anything. (Strange tax law? But they’re just being fair – if you wouldn’t pay tax on gains, you can’t offset tax on losses. And for shares held for more than one year, no taxes apply on gains.)
You also stand the risk that prices will run away. Because you could sell on Saturday and watch helplessly as the stock hits the upper circuit on Tuesday. That’s a risk you simply have to take, because while Bond Baba is smart, he cannot predict prices.
You can only offset capital gains income this way. (Not any other head like interest, or rent, or salary). But we’ve been screaming from the rooftops about how we all need capital gains income. And that income comes from bonds, from arbitrage buybacks (like our BEL trade) or even from selling property or gold – which are taxed even if sold in the longer term.
You can also do something of this sort using Bonus Stripping (See Bond Baba’s Post on that). Strip away bonuses, create short term losses, use them to offset profits.
Note: The US has specific laws to disallow such tax-saving techniques. India might introduce them too, but as long as we have the advantage, we must use it.
The Larger Point: Focus on Overall Returns
This Diwali, we ask you to sit back and look, not at individual stocks but at the larger picture. Yes, we had a Gujarat Alkali giving us 30% in two months. Yes, we had a quick 11% three-day mover in Arvind. But does it really matter?
What matters is the portfolio return. Overall. Including everything, gold, debt, property and equity. If you add them all up, and you’ve made 12%, that’s just brilliant. It doesn’t matter if one stock accounted for all of the gain, or they all chipped in. It doesn’t matter what one “tactic” does, because your strategy was to get overall returns that are decent – and 12% overall return is very decent.
That’s why you want to harvest losses. So that you can look at absolute returns like 12% and retain all of that 12% for yourself. On a bond. 12% returns are good. They’re better than nearly anything else out there. If it comes with reasonably low risk, they are just brilliant.
But you have to get yourself out of the thinking that: oh, 12% means after tax it’s just 8.5%.
With techniques such as tax-loss-harvesting, you can get all of that 12% and keep it.
That is really the gift you give yourself. Fight those demons, harvest those losses, and have a wonderful Diwali!