Realized Investment Portfolio Management

Realized reviewed in Barron's

2010-09-07T19:00:00-04:00

In her August 23rd review of a trio of New Apps With Investor Appeal, Theresa Carey said:

Electronic Investor

"Realized will generate a Schedule D for you whenever you want, so you can keep an eye on your short-term and long-term capital gains as the year progresses. The program displays your largest unrealized tax losses, which you can sell to offset your capital gains, minimizing your tax payments."

Theresa has much more to say about Realized in her article.

Making cost reduction easy for your equity portfolios

2010-08-11T14:45:00-04:00

No consensus exists as to the best method for building an equity portfolio. Some invest passively with index mutual funds. Others prefer a more active approach by picking individual stocks. Everyone wishes for above average returns and a secure retirement in comfort.

Regardless of individual preferences, prudent management of an equity portfolio will consider, at a minimum, these three practices:

*Asset allocation* and *diversification* to balance risk and expected return
*Performance monitoring* and adjusting holdings
*Reducing costs* to a practical minimum

Doing this well can be hard work. Those who are unwilling to devote the time and effort may choose to pay a financial professional to handle their investments.

Make cost reduction easy

If you have decided to make your own investment decisions, you may have already found it surprisingly difficult to manage your equity portfolios on the web. You can track the value of your stocks minute-by-minute, but not much else. A diligent investor might have to resort to tracking their portfolios with spreadsheets.

Following the above practices should be easier. One reason we founded Realized was to give individual investors a genuine cost reduction tool.

The sell side can generate real expenses

One easy way to realize higher returns is by lowering your investment costs. And the biggest costs are not commissions or management fees, but rather the taxes on capital gains.

Most financial web sites are devoted to what might be called the buy side of investing. Financial analysts recommend countless stocks. Buying is easy and nearly cost free, with online brokerages and low commissions. You have a spectrum of choices: stocks, ETFs and mutual funds.

Almost no guidance exists about when and what to sell from your portfolios. You might be overweighted in the energy sector, but which stock should you sell? You can only sell a security that you already hold. The mass media simply has no interest in an audience of one that has a specific portfolio issue to address.

Closing a stock position also generates taxable capital gains. Selling the wrong security at the wrong time can have a catastrophic effect on your realized, after-tax investment return.

Each time a trade occurs, it also changes your asset allocation. This has the potential to change the risk versus return profile of your portfolio. Along with the control over making your own trades comes the potential for destruction.

Managing a portfolio successfully requires some discipline with regard to selling securities.

Forget about timing the market: focus on timing your portfolio

By netting out gains and losses, many investors can sharply lower their tax burden. Turning unrealized losses into actual losses allows for other sales to become literally tax-free. This helps when you want to rebalance and improve your diversification.

Some investment software apps focus on calculating your capital gains tax near the end of the year. You discover where you stand after the fact. By then, it may be too late to offset gains with losses. You are stuck with a capital gains tax that might have been avoided. This approach *fails* to reduce costs to a minimum.

Realized aims to change things

Should you buy this stock, or sell that one, and how would it affect my portfolio? For those investors who need a tool to assist with such decisions today, Realized can help.

Realized-app.com launch

2010-07-29T16:30:00-04:00

Realized-app.com is now live and available to everyone. Today you can sign up for free and try it with your portfolios.

For our initial rollout, we focused on providing you a tool that fills some big gaps that other providers miss. The product tour shows a few details about what it can do for you now. While Realized already minimizes your capital gains tax and handles your Schedule D-1, we also expect to do much more.

After you try it out please share your feedback at our support center, or email us directly at support@newforge-tech.com.

Beta test period nearing an end

2010-07-21T15:15:00-04:00

As we wrap up the functional changes that we discovered during the Realized app beta testing, one new feature stands out. Early on, we saw that stock splits complicate the calculation of capital gains. One of the first features built into our automated tax lot setup included the handling of stock splits.

For any lot affected by a stock split, the Realized app will calculate the number of post-split shares. This requires no effort on the part of the user.

Mergers and tax lots needed a solution

During the beta test, we came across the merger of WYE (Wyeth) with PFE (Pfizer). The merger is actually a taxable acquisition using both PFE shares and cash boot.

We wondered how the thousands of WYE shareholders calculated the cost basis in their new PFE shares. Depending upon the cost basis for each of their pre-merger WYE tax lots, many had taxable capital gains, even though they sold no WYE stock. Some avoided the headache and passed the problem on to their tax accountants.

To provide our customers with full automation of the tax lot process, we went forward with adjusting tax lots for mergers. Going beyond the WYE/PFE merger, different merger types (either all stock, all cash or stock plus boot) require different handling. The end result: Realized will effortlessly maintain the cost basis for all tax lots, including stocks going through mergers.

No more headaches.

Public launch imminent

If all goes according to plan, next week we will begin a preview period during which anyone may setup a Realized account. To receive a notification when the preview begins, go to www.realized-app.com.

Transaction costs for stock trades include capital gains tax

2010-07-09T16:15:00-04:00

An online broker might charge a $10 commission to execute a stock trade. Your cost to buy 100 shares of a $50 stock would be $5,000 plus $10.

Trade commissions reduce before-tax gain

The commission would amount to only 0.2% of the principal invested. A few months later, you sell the stock for $60. As before, you would incur a $10 commission.

After subtracting the commission costs, you net $980 before taxes. The commission has reduced your net gain by a full 2 percent.

Short-term capital gains tax far exceeds commission cost

A short-term gain brings on a tax that lowers its return by 35 percent if you are subject to the top marginal tax rate. The capital gains tax on a $980 short-term gain would total $343.

This tax cost is 17 times greater than the round-trip commissions cost.

Long-term tax rate still takes a big bite

Had you held the stock more than one year before selling, the capital gain would be long-term. Such a long-term gain is taxed at only 15 percent.

For a $980 long-term gain, the capital gains tax would total $147. Waiting to realize a long-term capital gain results in a tax cost more than 7 times that of the trade commissions.

Delay capital gains tax by delaying a stock sale

A trivial way to delay the tax cost is to delay selling the stock. While the gain remains unrealized, it incurs no costs. Unless your asset allocation plan dictates that you dispose of the position, holding an unrealized gain is the best method for lowering your investment costs in the current year.

A dollar today is worth more than a dollar next year. Postponing the tax leaves you with more cash to invest now and discounts the tax cost in a future year.

Avoid the tax by offsetting the capital gain with a capital loss

Actually, capital gains tax is not calculated individually for each stock sale. If you must sell a stock with a short-term capital gain, you might look for another holding that has an unrealized short-term capital loss.

Selling another stock with a $1,000 short-term loss will more than offset the $980 short-term gain. This would leave you with zero net capital gains tax.

Rather than waiting until you have a gain that you want to realize, you may want to employ tax loss harvesting to recognize those losses as they arise. No investor sets out to lose money after buying a stock. Those who hold onto those losses when they could use them to offset gains miss a certain way to lower their tax.

Tax loss harvesting and the wash sale rule

2010-06-22T16:45:00-04:00

In the preceding post we noted the risk of an unrealized capital loss becoming long-term due to a wash sale. Tax loss harvesting also creates a situation constrained by the wash sale rule.

Tax loss harvesting

As in the preceding post, suppose you bought 100 shares of BP (BP plc ADR) at $50 per share on June 15, 2009. Less than a month ago on May 26, 2010, BP stock was at $43 per share. You had an unrealized short-term capital loss of about $700.

Rather than buying more BP stock, you sold 100 shares for $4,300. This action is also known as harvesting a tax loss. This loss would offset any short-term capital gains in your taxable portfolios.

Two weeks later on June 9, BP closed at $29.20. To rebalance your asset allocation, you were anxious to restore your holding in BP. On June 10 you bought 100 shares for $3,100. This purchase triggered a wash sale and negated the whole purpose of harvesting the tax loss.

Wash sale effect on cost basis

The short-term loss that you recognized on May 26 would be disallowed as a wash sale, because you bought substantially identical stock within 30 days after the sale.

To account for the wash sale, you must add the disallowed loss to the cost basis of the purchase that triggered the wash sale. In this case, the tax lot for the June 10 purchase had its cost basis raised by $700 to $3,800. You also change the beginning of the holding period of the tax lot to the purchase date of the stock sold.

The tax lot now has an unrealized loss of $700, and its holding period began on June 15, 2009. On June 16, this loss became long-term.

Tax loss harvesting starts a 30-day wash sale window

Recognizing a capital loss in a taxable portfolio sets up the potential for a wash sale during the next 30 days. To avoid a wash sale that would disallow the prior capital loss, you have two choices.

You can wait 31 days after the loss before buying replacement stock. While simple, this choice has a major drawback. During the period when the portfolio lacks the holding that had been sold, your asset allocation may differ from your chosen allocation.

Should maintaining a balanced asset allocation be of primary importance to your investment strategy, you can immediately replace the BP stock sold with similar stock in the same industry. As a substitute for BP, you might purchase another international oil company such as XOM (Exxon Mobil), RDS.A (Royal Dutch Shell) or CVX (Chevron Corp).

Wash sale risk with unrealized capital losses

2010-06-10T08:45:00-04:00

On June 15, 2009 you bought 100 shares of BP (BP plc ADR) at $50 per share. About two weeks ago, BP started its top kill operations. At $43 per share, BP was well below its 52-week high of $62.

With hope running high, you bought 100 additional shares for $4,300.

Yesterday, the BP ADR closed at $29.20. You have fallen into deep water, with no clear vision of the horizon.

Your 200 share position in BP consists of two tax lots. The first, year-old tax lot has an unrealized loss of about $2,100 (-$21 times 100 shares). For the second, more recent tax lot you have an unrealized loss of about $1,400.

Wash sale effect on cost basis

If you sell the first tax lot for a loss, you cannot deduct that loss from your net capital gains. The loss would be disallowed as a wash sale, because you bought substantially identical stock within 30 days prior to the sale.

This is the point where most discussions of the wash sale rule end. But the real damage has only just begun.

To account for the wash sale, you must add the disallowed loss to the cost basis of the purchase that triggered the wash sale. In this case, the second tax lot has its cost basis raised by $2,100 to $6,400. You also change the beginning of the holding period for the second tax lot to the purchase date of the stock sold.

The second tax lot now has an unrealized loss of $3,500, and its holding period began on June 15, 2009. Next week, on June 16, this loss will become long-term.

Avoid a wash sale that creates a long-term capital loss

Before your recent purchase two weeks ago, the first tax lot had an unrealized loss of $700. More significantly, the holding period for that lot was approaching one year. An earlier post pointed out the importance of recognizing short-term losses before they become long-term.

Adding to a stock position which has an unrealized capital loss starts a 30-day wash sale window. During that window, a sale of the stock for a loss will be disallowed. Particularly worrisome is when the window stretches the holding period of a tax lot beyond one year.

Unrealized capital gains are real

2010-06-04T19:00:00-04:00

How many times have you heard someone say, "You don't have a loss until you sell"? If that were true, it would also hold true for capital gains. Few investors will dismiss their unrealized gains as mere paper gains.

Handle unrealized capital gains to your advantage

Recognizing a capital gain triggers a capital gains tax, at short or long-term rates. In a taxable portfolio, the effective value of all unrealized gains should be discounted due to the potential tax. Avoiding or delaying recognition of a gain preserves the gain and avoids the tax.

Long-term capital gains get a favorable 15% tax rate. Even so, that cannot compare with the zero rate on unrealized gains. Whether short or long-term, the best approach to handle capital gains: do not disturb them. At some point in the future, when you really need the funds, your capital gains will still be there.

Paper gains are the best.

Benefit from recognizing a capital loss

No investor sets out to buy a stock that will fall in value. Nevertheless, any stock position carries such a risk.

Selling a stock for a capital loss provides a tax benefit. To exercise that benefit, you must sell the stock. Sitting on an unrealized loss will not change the loss. The harm in doing nothing, though, is giving up the tax benefit from recognizing the loss.

An unrealized capital loss is real. Take it.

Tax loss harvesting beats buy and hold

2010-05-20T16:45:00-04:00

Buy and hold

You have decided to buy and hold a portfolio of 10 stocks in a $100,000 portfolio. After four months, the total value of the portfolio has risen to $103,000. One stock, Bank of America (BAC), has dropped 30% to just $7,000, but most of the other holdings have gains.

Given your belief that BAC will bounce back from its loss, you hold onto it. Six months later, the portfolio value is $110,000. The BAC has recovered all of its loss and has a value of $11,000.

Replace a losing stock with a similar stock

Rather than holding onto the BAC after it had dropped, assume that you sold it to realize a $3,000 short-term loss. With the proceeds from the sale, you purchased $7,000 of Wells Fargo (WFC). Replacing the BAC with a similar financial stock helped to maintain the portfolio diversification.

As before, the portfolio value rose to $110,000 six months later. At that point, the WFC position had also risen to a value of $11,000.

Tax loss harvesting

Capital gains tax works in reverse for a capital loss: for the benefit of the taxpayer. You can exclude from your taxable income up to $3,000 in capital losses. If you are subject to the top 35% marginal tax rate, this exclusion lowers your tax by $1,050.

By proactively selling a stock and harvesting a loss, you gained a tax savings. The simple buy and hold approach left $1,050 on the table. If you chose to invest the savings, tax harvesting would have raised your portfolio value to $112,050.

Cost basis after a stock split

2010-04-29T17:30:00-04:00

WFMI (Whole Foods Market, Inc) had a 2 for 1 stock split on December 28, 2005. Before the split you bought 300 shares of WFMI at $60 per share.

You later sold 100 shares at $75 each, leaving 200 shares of WFMI in your portfolio.

Due to the stock split you received 200 additional shares for a total of 400 WFMI shares.

Realize a capital gain

During 2008 you sold 200 WFMI shares for $20 each and realized a sale amount of $4,000. To figure the capital gain (or loss), you need to determine the cost basis of the sale.

After searching your trade history, you find the 300 share purchase with a trade amount of $18,000 (300 shares times $60). The WFMI position had a cost basis of $60 per share before the split.

The sale of 100 shares prior to the split did not change the cost basis per share. After that sale the 200 shares of WFMI had total cost basis of $12,000 (200 shares times $60).

A stock split leaves total cost basis unchanged

The stock split had no effect on the $12,000 total cost basis. The 200 shares received due to the stock split did halve the cost basis per share to $30 ($12,000 divided by 400 shares).

The sale during 2008 of 200 shares would have a cost basis of $6,000 (200 shares times $30 per share). Thus, you realized a long-term capital loss of $2,000.

A tax lot clarifies the effect of a stock split

A 300 share purchase would create a new tax lot with a cost basis of $18,000. This tax lot would have its shares reduced to 200 by a sale. The sale would lower the total cost basis to $12,000. At $60, the cost basis per share would remain unchanged.

After a 2 for 1 stock split, the share quantity of the tax lot would double to 400. The total cost basis would stay the same. With twice as many shares, the cost basis per share would halve to $30.

Divide split shares among tax lots for multiple purchases

Your portfolio might include several WFMI purchases with share quantities of 250, 350 and 400. The broker would report that you have received 1,000 shares due to the stock split.

The cost basis and holding period for the added shares correspond to each of the three purchases. Without using tax lots, sorting out the cost basis of various shares can become a burden.

Imagine an optimal Schedule D

2010-04-12T15:15:00-04:00

What should an investor do when a stock has a loss since its purchase? In the hope that the stock may recover, some investors continue to hold the loss.

Now that the tax season is winding down, taking a look at your 2009 tax return could provide some fresh context for this situation.

Buy and hold could give away a tax break

Each year, taxpayers may subtract up to $3,000 in capital losses from their ordinary income. For those in the 35% tax bracket, this amounts to a tax reduction of $1,050.

Under a buy and hold strategy, an investor may not have sold any stock during 2009. By doing so, he would have avoided paying any capital gains tax.

If this investor's portfolio had nothing but unrealized gains, he could do no better. Most investors are not that fortunate.

Sell to realize a capital loss and get a tax break

No investor is perfect with their stock picking. Anytime a new stock is purchased, a risk exists that its price may fall.

By selling a stock for a loss, an investor can lower his overall capital gains. If he realizes losses equaling $3,000, he enjoys the maximum tax break.

Offset further losses with capital gains

If the total capital loss exceeds $3,000, the excess is carried forward to the next year. Delaying by a year the benefit of the tax break dilutes its value, due to the time value of money.

One way to avoid a capital loss carry forward is to sell a different stock for a gain. This also provides a convenient chance to improve the degree of portfolio diversification. Overweighted stocks tend to be those with unrealized gains.

Let long-term capital gains wait a little longer

With its tax rate of only 15%, some investors might choose to realize a long-term capital gain. As discussed in an earlier post, unless the investor is retired and no longer adding money to the portfolio, taking such a gain is unnecessary and costly.

Get the maximum tax reduction on Schedule D

An individual's Schedule D could have a net short-term loss of $3,000, with zero long-term capital gains. In this case, he will benefit from the maximum tax break for capital losses.

If his portfolio has unrealized losses and he reports a smaller loss, or even a gain, he may be just another irrational investor.

Unrealized capital gains preserve wealth

2010-03-22T19:30:00-04:00

Many investors take care to wait for a gain to become long-term before selling. By doing so, they benefit from the relatively low 15% capital gains tax. Here we take another look at when to sell stock.

Delay recognition of all capital gains, even long-term gains

Once the market value of a stock position rises above its cost basis, an investor has an unrealized gain. When she sells the stock, she will realize the gain and incur a capital gains tax.

In November 2009, she had an unrealized $10,000 long-term gain. Rather than recognizing that gain in 2008, she waited until February 2010 to sell the stock position.

She has delayed a $1,500 tax, $10,000 times 15%, by one full year: April 2010 to April 2011. By postponing the tax, she can invest the $1,500 for a year and earn $75, assuming a 5% return.

Unrealized gains are even more valuable

An unrealized gain is subject to a potential, future tax. Just when that tax becomes payable is at the discretion of the investor.

The ultimate purpose of investing is to preserve wealth over time. An investor need not sell an unrealized gain. By holding the gain, the gain will compound its return and grow like a tax-deferred account, such as an IRA.

In a sense, the investor can enjoy the benefit of the compounding effect of unpaid deferred tax. If and when she needs to withdraw the money from the portfolio, she may choose to realize the gain. For many investors, that day will come during retirement.

Costly to offset a long-term capital gain against a short-term loss

2010-02-27T20:45:00-05:00

Short-term losses directly offset short-term gains. Investors can also use the net capital loss to lower their ordinary income by as much as $3,000. In the best case for those subject to the top 35% marginal tax rate, a $3,000 capital loss could reduce the tax due by $1,050. Taxpayers in lower tax brackets see smaller tax reductions, though.

How to dilute the tax reduction value of a short-term capital loss

Suppose that year to date, an investor's portfolio has already realized a net short term capital loss of $3,000. The portfolio also has $10,000 of unrealized long term capital gains.

If she sells stock to realize a $3,000 long-term gain, the short-term loss will offset the gain. This leaves her with zero net capital gain. With zero gain, she has zero capital gains tax due.

Had there been no short-term loss, the $3,000 long-term gain would have incurred a tax of $450 (15% times $3,000). By offsetting the gain, the net short-term loss has also offset the $450 tax. Used this way, the $3,000 loss is 'worth' only $450. She has wasted $700 of the potential value of the short-term loss.

Delay long-term gains to years without short-term losses

The investor might have a better choice in this situation. Suppose she waited until the next year to realize the $3,000 long-term gain. Without a loss to offset the gain, the capital gains tax would be $450 (15% times $3,000). In the prior year, her $3,000 capital loss lowered her tax by $1,050. Looking at both years together, her net capital gains tax would be a negative $700 ($450 minus $1,050). She has recovered the full potential of the $3,000 short-term loss by avoiding its offset against a long-term gain.

Beta testing to find our minimum viable product

2009-12-14T19:15:00-05:00

Before anything else, the Realized app must handle two aspects of a stock portfolio. One concerns the capital gains that have yet to be realized. The other involves reporting the realized gains for Schedule D.

For the unrealized gains, the app maintains the cost basis of stock holdings within tax lots. It also adjusts the basis of a lot after a corporate event such as a stock split.

To calculate a realized gain, the Realized app matches a sale with a tax lot. Properly gathering these gains for Schedule D-1 also requires the detection of any wash sales.

With the above features in place, we have reached the point where the app has a solid foundation. Our goal is to take the existing feature set to the next level with a minimum viable product.

If you would participate as beta tester and try out the latest, pre-launch version of the Realized app, go to www.realized-app.com/beta. Successful portfolio management involves a number of factors. With your help, we can make the best choices for the future development of Realized.

Cost basis for stock depends on tax lots

2009-10-22T10:45:00-04:00

Early each year, investors receive a 'Proceeds from Broker Transactions' report, IRS Form 1099-B, from each of their brokerages. This form lists the gross proceeds from stock sales for the prior year.

The bad news: the Form 1099, with just the sales listed, provides only a part of the data needed to determine the capital gains for Schedule D. For each sale, the amount of capital gain, or loss, is the difference between the gross proceeds and the 'cost or other basis'.

Cost basis depends on which stock was sold

From IRS Pub 550, the cost basis for a stock position is the purchase price plus any purchasing costs such as commissions. To know the purchase price, one needs to identify which stock was sold. When an investor has made purchases at various times, this can become difficult.

Identify stock sold with tax lots, not stock trade history

Every opening trade to purchase stock creates a new tax lot. The cost basis of the lot is the purchase price plus any purchasing costs.

Later, a sale of stock will reduce the number of shares in the lot being sold. When all of the shares are sold, the lot is closed. If only a portion of a lot is sold, the lot will have its shares reduced by the number of shares sold. The cost basis is the fractional part of the shares sold to the total cost basis of the lot.

A sale of stock may also involve multiple lots. Each lot will have a distinct cost basis and holding period. Such a sale will result in a separate capital gain or loss for each affected lot.

Cost basis record keeping is a burden

The taxpayer bears the responsibility for tracking the cost basis to substantiate their capital gains. Along with a list of current stock positions, brokerage reports include the history of trades. Except for the simplest cases, neither coincides with the tax lots.

Investors have few tools to help track cost basis over time. Many use tax preparation software to calculate capital gains at year-end. While this may appear to be a reasonable approach, this may not result in the lowest tax.

Some do maintain a record of each tax lot in their portfolios. Nevertheless, taking on this task with a spreadsheet would be time-consuming and error-prone.

A cost basis app for individual investors

A great cost basis app would make tax lots easy. Investors who know their tax lot situation can make better trades year-round. This helps them get better after-tax returns, since they trade stock with an eye on lowering their capital gains tax. With the tax lots already set up, calculating the capital gains and Schedule D becomes automatic.

Providing investors with a simple tool to maintain their tax lots is another reason why we developed the Realized app for managing stock portfolios.