On Capital Gains & Losses Conclusion Tax Deferred Accounts.

Today we'll finish up discussing how we believe investors should approach capital losses in tax deferred accounts. The first thing to understand is that none of the potential tax benefits that apply to harvesting losses accrues to tax deferred accounts. You take a loss here its a loss with no governmental benefit. Never-the-less I think that everything we discussed regarding losses in taxable accounts also applies here, including trying to lower the cost basis of securities. That will likely mean realizing capital losses at some point. Here are some points to consider.

The loss has already occurred. Forget the old sayings about how it's not a loss until you book it. That's simply not true. Your portfolio is graded everyday by Mr. Market. Good grades are gains and bad grades are losses and its value is what the market will pay for your securities. Inevitably after a crash that worth is usually a good deal less. Taking the opportunity to lower your cost basis means that at some point you are likely adding to securities you like and perhaps selling parts or all of them at higher prices. When we've experienced declines of the magnitude we've seen in the past few years it is inevitable that in this process you will be booking losses previously incurred.

Losses as we have stated are part of the investment business. Everybody, even Warren Buffett, will incurr them during their careers. The investment process is a forward looking discipline. Each security should be analyzed with an eye toward the future. Inevitably this will mean that investments with a poor or cloudy outlook should be removed, without regard to what has already occurred. If this means at some point booking some losers then so be it. It is unrealistic to expect that a portfolio will never have any losers or poor performers. Nobody bats 1000 in this business.

Taking losses removes the often psychologically debilitating process of constantly staring at losing positions. For most of us it is often hard to stare at the same money losing investments, sometimes in the case of a crash, year after year. Too often the inability or unwillingness to remove these assets also removes the discipline needed to properly judge a portfolio and can blind investors to better opportunities in the future. Pruning losers by removing them or attempting to lower your cost basis can over time help take care of this problem.

There is never anything wrong with adding to good investments. Ideally you want to do this when the market is giving them away. That will often be when the world looks like it is coming apart as it did this past year. Investors who purchased securities at any given time in the last 8 months have likely felt scared, foolish or both. Right now with the market having advanced for much of July they are likely being rewarded. If they did the right thing by working to lower cost basis even in tax deferred accounts earlier this year then that strategy is currently reaping dividends. Assuming all of the criteria we discussed yesterday apply-that is you still like the investment merits of the security in your portfolio and its decline is largely an issue related to a market correction or crash-that I believe you apply the same criteria on lowering cost basis as we discussed in taxable accounts.

Finally I realize that it is often hard to realize these losses and not everybody will agree with my approach. But losses are a part of the process and it is one each of us must become used to. Doing it in a correct manner can have major positive implications for investment portfolios over the longer term.

I hope you enjoyed this investment series and found it useful. Look for a new series on investment risk starting sometime after Labor Day!

We are covering in this series what we believe is the proper procedures regarding the application of capital losses for investors at Lumen Capital Management, LLC. If you are not a client of our firm you should either do your own homework or consult with your own investment advisor before implementing any of these strategies listed in these posts. Also you should consult your own tax professional before implementing your personal strategy for capital losses. This series is a general overview and should not be considered personal tax advice of any kind. Please note as well that tax laws could change in the future which could impact the implementation of these strategies or negate some or all of the advantages of harvesting capital losses. Finally you should be aware that we have not covered all of the possible risks to which ETFs could possibly be subjected. When discussing the risks regarding ETFS, we have no knowledge nor do we make any guarantees whether some of the same issues and risks particular to equities could ultimately affect ETFs as well. Again please consult your own investment advisor or do your own homework as to the appropriateness of these investments for your portfolio You can also visit any of the popular ETF websites for a further discussion of this topic.