Transcript:
Easan Arulanantham:
The first question is kind of a common problem that a lot of our clients are having is, what do I do with a highly appreciated investment that isn’t performing very well in this market, you know, the markets down, but it’s performing worse than the market?
Tom Vaughan:
Yeah. So we’ve got some of that within our practice, people that have individual stocks, they work at a company here, a tech company. And so it’s, they’re doing worse than the market. And but they still have huge gains, we have, you know, some positions that we have, you know, even the S&P 500, I’ve got clients that have doubled their money in the Vanguard, S&P 500, you know, ETF DOL they might have back in 2011, or something. And one thing about ETFs is they’re super efficient, they don’t pay a lot of capital gains. The bad thing is that you end up with a lot of, you know, unrealized gains that make it hard to make, make a change. So it’s actually there’s a bit of math to involved in, I’ll give you some very simplified, believe me, for those of you that are, you know, really good at math, you’re probably going to cringe at this to be honest, but I have a million dollars, let’s say, and I double my money, I put in 500,000, I’ve got a $500,000 gain, it’s not doing well, right. And maybe it was worth a lot more before. But I am tempted to sell it just because it’s doing so much worse than the market. But I have a $500,000 gain. And that can create all kinds of problems in terms of what tax bracket I’m gonna get into. But the way it works for capital gains is sort of a flat tax brackets are pretty wide, I’m probably going to pay 15 or 20%. Right? Probably closer to 20% on a on a on a 500,000 AR game. But nonetheless, plus, if you have a state that taxes capital gains, like we do here in California, they just considered ordinary income.
So you can get all the way up into a 13% bracket here in California, without too much effort. So let’s just say I have to pay 30% and tax, that $500,000 gain 30% of tax, I have to pay 150,000 in tax, right. And so Whoo. That’s a big difference. Right now, I have had a million I sold it, I have to pay 150 and tax I now have 850,000. Right. So I have to think about that and say, Okay, that’s down 15% guaranteed if I sell it. Now, if I sell it, and it actually drops 30% Wow, that was perfect. I’m glad I sold it. Because I’m down 15. Right. You know, again, you dropped some because you still held, you know, potentially something, but let’s say you sold it all. And having said that, how many things dropped 15%. You know, I mean? So when we look at, say the Vanguard S&P 500 index, and you’d say okay, in order for me to break, even here, this has to drop at least 15%. And hold on to it, you know, because that’s not very common. I’m looking at in video or some other stock, right, that has the potential to drop or jump 15% in like, a week, you know, wow, okay, maybe, but I’d have to really have some conviction that this might happen, right? And that’s what makes it so difficult. It’s why it’s probably better in a lot of cases like that, to buy and hold. So you’d want to do the calculation, how much is the gain? If I lost 30% of that gain? Just again, using an easy number, you might be less? But then how much would my holding have to drop before I get to break even? So if it has to drop two or 3%? Oh, okay, I might do that, right? Because that probably happens or could happen. You still have to get back into something in order for that to work, which isn’t easy. But if it you know, it’s going to drop a significant amount based on the tax payments. Okay, so. So that’s, that’s the first part you need to kind of calculate, you know, what you’re going to lose what your breakeven point is going to be. And then, you know, what is the likelihood for this particular security to move that much?
Right. All right. So there’s that. The other option is to kind of hedge the position. So let’s say I have a million and Apple, I paid 500,000 for it. I don’t want to sell it. Yes, it could drop 15%. But I don’t want to pay the tax. And so what I could do is I could go by, you know, a an inverse position, like the pro shares S&P 500 inverse. And actually, if it’s Apple, I might want to buy the pro shares, NASDAQ 100 inverse, which Apple’s a part of, they call that the Q QQ. And this goes the opposite direction of that. Not perfectly, and these are not vehicles for the faint of heart. They do move pretty well evenly with these other pieces. But the object would be that if I lose 10% into an Apple, if I could make 10% in something else, at least I’ve neutralized my potential loss without having to sell Apple. And I don’t have to take the game. The risk is the market goes flying up, and I’m making nothing, you know, because I’m making money on Apple and losing money on the inverse portion. So you’re literally neutralized, and again, I’m being very generic error you want actually neutralize? Exactly, there’ll be some discrepancy between Apple and QQ cues or whatever, right. But in general, that’s the thing I’ve seen happening quite a bit recently, my effect has been a lot of money pouring into these inverse funds. And I think that’s a way if you have a highly appreciated asset, at least to look at, as far as that goes, and, and again, not everybody has that extra money sitting over there someplace that they want to do this with.
Do people ever say, Hey, I can’t sell everything, but let’s say let’s say, well, 10% or 20%? Yeah, there’s a holding. So we you sort of trim it, but you don’t completely?
Yeah, and especially if you’re looking at, you know, your tax brackets and the capital gains levels, so, hey, you know, I can stay within this 15% level, if I only sell 10%, you know, so that’s gonna save me some taxes. And, you know, yes, exactly. Right. So kind of paring back a chunk of what you’ve got in there just to capture some gain, right? Well, you have and, you know, assuming it does go down some more. So, yeah, that would be the kind of the middle ground between those two. So it’s, it’s a really good question. It’s something that comes up a lot. We see it constantly eat within our practice within the holdings that even we have purchased for clients. We see this within the valley here, you know, Silicon Valley is full of companies like Apple, and Google, you know, all of these big Nvidia and all these companies that have had huge huge runs and their stock. And you know, if your work there, you’re getting a discount and a lot of times in the way that these programs work, so you can have an even bigger game as far as that though. So there’s a couple strategies to take a look at and how to try to hedge that it’s not it’s not easy, but it’s a good problem to have. Yeah, still a problem.