You Know This Person—the Average Investor with Self-Inflicted Wounds (Part 2 of 4)
May 20 2008
Part 2 — The Self-Inflicted Wound G&F (Greed and Fear) syndrome in practical terms means you buy when things look good and sell when things look bad. The “C” fund in the TSP looks too good to pass on when it is returning 15%. So you buy; probably after selling another one of your funds that’s tanking. Bottom line, you bought high and sold low. (Ummmm, isn’t that the opposite of how the old saying goes?)
Eventually, the “C” fund goes over the top and the returns won’t look so good and another fund will be peaking. The process starts all over. Now you sell the “C” fund at the bottom (after buying it at the top) and you buy another fund at the top. And so it goes into the future.
Goodbye investment returns. Greed got you to buy high and fear got you to sell low. Emotions have no place in investment strategies. You have to use knowledge and history to formulate your investment game plan. Make your plan completely emotionless.
There is always a reason for not investing or for changing your holdings in most peoples’ minds. Think back to all that happened during the 1900s. Two world wars, great depression, cold war, nuclear weapons, USA-USSR relations, Mid-East relations, Korea, Vietnam, 1973-1974 economy, late 1970s inflation and interest rates, Iran hostages…got it? There were plenty of highs and lows in the stock market.
When was the best time to invest? Always. How many times have you thought, “Gee, I wish I could have bought Wal-Mart in the 1980s?” Well, you didn’t say “gee.” The point is the people who bought Wal-Mart in the 1980s held on to it and now you envy them. They didn’t float in and out of it like the people who buy and sell their holdings based on greed and fear.
The problem with buying low is that people would rather have their tonsils taken out by the Jack the Ripper than buy investments when the market is taking a beating. I was practicing after 9/11. Trying to get people to invest after that was like building a house in a hurricane.
It turned out that 2002 was an outstanding time to buy as the market was full of fear. “…be fearful when others are greedy and greedy when others are fearful.” You can’t beat a good Warren Buffett quote at this point. Understand the nature of the stock market and you will know thy enemy. Knowing your enemy allows you to establish appropriate plans of attack.
I too believe in long term investments. However, I am well ahead on a stock I have held for 45 years and am considering selling half to capture the gain during this low tax rate on gains [selling more gets into AMT].
I make two assumptions; one possibly more valid [predictable] than the other:
1. The Democrats win in November and the capital gains rate, now 15%, goes back to the normal marginal rate – assume 25% for most of us.
2. The market will fall another 15% this year and then gives steady 8% gains for 7 years [fairly realistic [conservative] guess].
Assuming no AMT involvement, will you be farther ahead in 7 or 8 years by selling half now, reinvesting that sum net of taxes in a year [new basis] or by staying in and riding it down and then paying the 25% rate on all of it at the cash out? Needless to say my basis is very low on the early shares. Is there a simple way of calculating the wisdom of such a move, granting that the assumptions are just that!
My clumsy attempts at figuring this always seem to favor selling, paying the lesser tax and coming back in. This holds true even if the market is neutral for the next year. Interesting exercise!
bbrockmann
bbrockmann,
Shane is on leave this week, but I will toss my thoughts in on this. First, I think that the likelihood of capital gains tax rates going up after the current rates expire in 2010 is relatively strong, given the current political climate. Therefore, taking sequential gains in 2008, 2009 and 2010 to benefit from the lower rates probably makes sense.
Another option would be to donate a portion of the stock to a qualified charity, taking a tax deduction for the full fair market value on the date of gift. You pay not capital gains taxes, the charity pays no capital gains taxes and you get more wiggle room around the AMT issue.
Finally, if you are supporting any family members, such as adult children, highly appreciated stock is an excellent gift. They inherit your basis, but will be less likely to fall afoul of the AMT. For 2008, if they are in the bottom two tax brackets (10 and 15 percent), there is a 0 percent tax rate on long-term capital gains, so asset shifting is a big plus.
Best,
Phil Dyer, CFP, RLP
MOAA
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