Don't invest based on tax-policy shifts
Given the low rates Americans enjoy now, tax hikes have long seemed inevitable.
The S&P 500 ($INX) shed nearly 5% in the two weeks following President Obama's reelection. A number of concerns have been cited for the sell-off.
I wrote about the fiscal cliff last week in Fiscal Snooze, noting that I wasn't particularly concerned about it, and I feel the same way about this week's subject: the threat of higher taxes.
Many investors appear to have worked themselves up into a tizzy about the increased likelihood that they'll soon be paying higher taxes. Given the historically low tax rates that Americans are enjoying right now and the precarious state of the public coffers, tax hikes have long seemed inevitable. The election results have confirmed this for many, and the president's legions of passionate critics are no doubt feeling especially emotional about it.
No one knows exactly what's around the corner right now in terms of fiscal policy, but a bevy of potential tax hikes are on the table. The 15% capital gains rate could go up -- one factor widely said to be weighing on shares of Apple (AAPL), which is down about 19% since mid-September.
The 15% dividend tax rate could rise. Tax deductions might be cut back. Obamacare comes with a 3.8% Medicare tax for high-earners, and estate and gift taxes could also increase.
Of course, they might not -- and investors who make rash decisions in reaction to the political headlines of the moment could wind up paying a heavy price for it. Taxes certainly have a material effect on investment performance, but I'm skeptical of those who think they can react to the national political scene and thread the needle of tax-policy changes in their portfolio of stocks and bonds.
If you've been contemplating taking a capital gain, then now may be the time to pull the trigger, but I would be wary of anyone suggesting that you should change your investment strategy in any substantial way due to the threat of higher taxes.
The New York Times recently reported that John Moorin, the founder of a medical equipment company near Indianapolis, said he sold about $650,000 in dividend-paying stocks like McDonald's (MCD) and Coca-Cola (KO) after the election.
"I love these companies, but I'm so scared that now all of the sudden I'm going to get taxed at such a rate with them that they won't be worth anything," said Moorin, according to The Times.
I wish Moorin luck with his trades, but I have to say that I cringe when I hear a comment like that.
If you love a company, the last thing you should do is sell its shares based on fears that its dividends might be taxed at a slightly higher rate. A great company that delivers a long-term track record of investment returns -- including steady dividend payouts -- over the life of your portfolio isn't going to be rendered worthless by any stretch as a result of any of the tax policy changes that are on the table.
Let's take a quick reality check: the capital gains rate, which is currently 15%, was 28% under President Ronald Reagan. Maybe if it moves up to 20% we can still have "morning in America" again.
It's true that many investors are depending on dividends for income in this low-rate environment, and a substantial tax hike on those dividends will hurt them, but where else are they going to go now? The yield-starved bond market? If they own good stocks that pay a healthy dividend now, I'd stick it out.
Yes, stocks have sold off in reaction to Obama's strong reelection victory and the threat of higher taxes that comes with it, but it has only been two weeks. If tax increases actually happen, then stocks may sell off more, but where will they be a year from now ... or five or ten years from now? Stocks probably rallied at the time of the Bush tax cuts in 2003, but five years later was anybody celebrating those transitory market fluctuations as news of the global financial crisis was prompting reflections on the U.S. stock market's "Lost Decade"?
Patrick Boyle, an investment strategist with Bessemer Trust, recently published an examination of stock market reactions to tax-policy changes over the last three decades, and he concluded there is "no clear link between tax changes and U.S. equity performance." One reason for this, Boyle notes, is that Americans hold about $19 trillion in tax-free or tax-deferred retirement accounts, and the occasional change in tax policy has little to no bearing on their decisions as a result.
Maybe we should be loading up on dividend stocks in our IRA accounts, and taking advantage of this sell-off. If higher taxes puts the U.S. on a more sustainable fiscal path, then that should ultimately give confidence to investors and boost the stock market.
At the time of publication the author held shares of AAPL.
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