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Your goal as an investor is to build a portfolio that allows you to steadily accumulate wealth over time. But on the road to wealth creation, you might encounter some difficulties. Specifically, you may need to sell a stock when it is falling, which will affect this investment.
To be clear, many people’s portfolios are down since the start of the year due to the general turbulence in the stock markets. And that’s not a very good reason to sell a stock.
But let’s say there’s a stock in your IRA or brokerage account that’s been steadily losing value since you bought it. Let’s also say you’ve been tracking the company’s finances and have reason to believe that those stocks are worth even less money down the line. That’s a good reason to take a loss rather than sit back and get by.
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If this is the scenario you landed in, try not to stress. While investment losses can be frustrating and upsetting, they can also, in some ways, be to your advantage.
How to capitalize on an investment loss
Investment losses are not ideal. But you can use them to offset capital gains in your portfolio in a tax-free account.
Let’s say you’re sitting on a stock that has done remarkably well this year, even though the market, overall, has been uncertain. You might be inclined to sell this stock while it is rising and walk away with a good profit.
Normally, the IRS would be entitled to a share of this profit in the form of capital gains taxes. But if you’re sitting on a capital loss, you might be able to reduce or eliminate that liability altogether.
Let’s say that by selling this winning stock today, you would earn $5,000. If you have a loss of $5,000 on another stock you sell, you won’t owe the IRS anything.
Now suppose you are only aiming for a gain of $2,000 in the above scenario. You can always use your total loss of $5,000 to your advantage. That’s because the IRS allows you to offset up to $3,000 of ordinary income against capital gains losses.
Capital gains losses can be carried forward to future tax years. Let’s say you are looking at a gain of $1,000 in this situation, not $2,000. If you use your $5,000 to offset that $1,000 plus $3,000 of ordinary income, you can carry forward the remaining $1,000.
Dig deeper – but don’t beat yourself up
If you’ve lost money on a stock this year, it’s a good idea to see if you can figure out why. Maybe you haven’t spent enough time digging into the finances of this business. Or maybe that loss wasn’t avoidable – things just went downhill in the business and it wasn’t something you could have anticipated.
It’s a good idea to get to the bottom of why you’re sitting on a loss to potentially avoid making the same mistake again. But don’t give yourself too hard a time. It is quite rare that investors make all the right decisions. And brooding over a loss can make you lose confidence in your ability to pick stocks, so there’s no point in forcing that on you.
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