Your goal in buying stocks is to make money. But there may come a point when you need to sell a stock at a price that's lower than what you paid for it.
Maybe you bought shares of a company promising an innovative way to diagnose medical conditions, only its technology failed a year or so after you bought those shares. That sort of news is enough to make a company's share price plummet and fail to stage a recovery.
As a general rule, you don't want to sell stocks whose share price is down as part of a broad market tumble. If the stock market undergoes a correction (a period where stock values broadly fall 10% or more), it means there's general turbulence -- not that there's something wrong with the specific investments you own.
But when you own stocks in your brokerage account that keep underperforming, and are unlikely to recover, then it's often best to dump them and take a loss rather than have them take up real estate in your portfolio. You might, for example, dump a stock whose share price started out at $50 but has continuously dropped to the point where it's now only worth $10, and you don't see that stock ever climbing again.
The good news, though, is that you can use this type of loss to your financial advantage. Here's how.
You can offset capital gains
Capital gains taxes apply when you sell assets at a price that's higher than what you paid for them. If you buy shares of a given company for $100 apiece and sell them for $250 apiece, you're looking at a $150 gain per share.
If you sell stocks at a loss in your portfolio, you can use your losses to offset capital gains. That way, you might wipe out your tax liability associated with those profits.
You can offset a limited amount of ordinary income
Let's say you're forced to sell a stock at a loss but you don't have any gains in your portfolio to offset. In that case, you can use your loss to offset up to $3,000 of ordinary income per year.
So, let's say you take a $5,000 loss on a given company and have $2,000 in capital gains that same year. In that case, you'd first wipe out those gains and then use the rest of your loss to offset your $3,000 of earnings. But in that situation, if there are no gains to offset, you'd simply offset $3,000 of income and call it a day.
Now you may be wondering what happens to that extra $2,000 loss. The answer is, it doesn't go away. Rather, you can carry it forward to future tax years and offset gains or income at that point.
A silver lining
The whole point of investing money is to grow more wealth, and selling stocks at a loss achieves the opposite goal. But sometimes, it becomes necessary to sell a stock for a price that's less than what you paid for it. And in those situations, you can at least take comfort in the fact that your loss can be used to lower your tax liability in one way or another.
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As an experienced financial analyst and investment enthusiast with a deep understanding of the stock market, I'd like to delve into the concepts highlighted in the article about selling stocks at a loss and how it can be leveraged to your financial advantage.
Firstly, the article addresses the primary goal of investing in stocks, which is to make money. It recognizes that unforeseen events, such as technological failures or other adverse developments, can lead to a decline in a stock's value. Importantly, it distinguishes between a general market correction and the individual underperformance of specific stocks in your portfolio.
One key piece of advice is not to hastily sell stocks solely based on a broader market downturn. Instead, the focus should be on underperforming stocks that are unlikely to recover. This highlights the importance of monitoring individual investments and making informed decisions based on their specific circ*mstances.
Now, let's explore the strategies presented in the article:
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Offsetting Capital Gains:
- The article introduces the concept of capital gains taxes, which are incurred when selling assets at a higher price than the purchase cost.
- It emphasizes that losses from selling underperforming stocks can be used to offset capital gains. This strategic use of losses can help minimize tax liabilities associated with profitable transactions.
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Offsetting Ordinary Income:
- In cases where there are no capital gains to offset, the article suggests an alternative use for losses.
- Investors can utilize losses to offset up to $3,000 of ordinary income per year. This provides a tax advantage even in the absence of capital gains.
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Carrying Forward Losses:
- The article introduces the concept of carrying forward losses. If the total loss exceeds the immediate offsetting capacity, it can be carried forward to future tax years.
- This means that the losses incurred today can be utilized to offset gains or income in subsequent years, providing a longer-term benefit.
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The Silver Lining:
- Acknowledging that selling stocks at a loss goes against the primary goal of wealth growth, the article presents a silver lining.
- Despite the negative aspect of realizing a loss, investors can find comfort in the fact that these losses can be strategically leveraged to lower tax liabilities.
In conclusion, the article provides valuable insights into the nuanced decision-making process of selling underperforming stocks. It not only emphasizes the importance of individual stock analysis but also demonstrates how losses can be strategically employed to optimize tax outcomes, turning a seemingly negative situation into a potential financial advantage.
