I really don't mind
paying capital gains taxes since this event implies that I'm
making money in the stock market. Besides, as the old saying
goes, the only two things in life which are a certainty are
death and taxes. We can escape neither.
Over the years we have
had disgruntled clients complain to us about our realized
capital gains and the fact that they had to pay taxes. We
explain that our job is to pick undervalued stocks and when
a particular stock becomes very expensive, it is our duty to
sell it, regardless of the capital gains implication. But
taking profits, to many investors, is an extremely difficult
discipline. For instance, if a stock becomes fundamentally
overvalued and a mini-mania of price momentum has powered
the stock to unprecedented levels, the average investor will
usually want to hang on for a greater gain. This is where
greed sets in. On the other hand, when a stock collapses,
the average investor wants yesterday's price. Unfortunately,
there does not exist a "money-back guarantee" or a
return policy for common stocks. The stock market, after
all, does not follow the Canadian retail industry practice
of no questions / merchandise returns.
An important impediment
confronting the average investor contemplating taking a
capital gain is the phobia of paying taxes. Investors just
don't like paying capital gains taxes when they consider
that they have taken all the risk. Often this hesitation can
lead to disastrous results. For example, over the past six
months, we have met numerous prospective ABC Fund investors.
Many are refugees from the high technology sector and of
this group the vast majority have been longtime holders of
Nortel shares. During the course of explaining our ABC
Funds' investment style, the conversation inevitably shifts
to the prospective client's investment experience.
Invariably, many confess that they owned and held onto their
Nortel shares throughout its incredible price rise to a $124½
peak and never bothered to take any profits. They rode the
stock all the way up and have since experienced a tumultuous
price decline to Nortel's present level of $2.25.
It is an interesting
thought that from its peak price to its recent trough, we
estimate that over $360 billion of value has been vapourized
from Nortel shareholders' net worth. We attribute much of
this to greed. In fact, when queried further, the Nortel
holders would often explain: "Yes, I knew that Nortel
wasn't cheap, however, I didn't want to take a capital gain.
I wanted to postpone paying taxes." This point leads to
an interesting quandary: the dilemma of when to take a
profit in an overvalued investment versus one's natural
propensity to postpone paying the inevitable capital gains
tax. There is no argument that this is a very tough
decision; it is often a question of how piggish an investor
wishes to be.
Ultimately, we believe
that investors must separate the determination of selling an
overheated common stock as opposed to one's phobia of paying
taxes. Both are completely separate decisions. Overall, it
is our view that, as investors, we must push aside the greed
aspect, stick to our investment knitting and adhere to
strict buy/sell disciplines, regardless of the tax
consequences.
Irwin A. Michael
