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Tis the Season for Tax-Loss Harvesting

Tis the season of tax-loss harvesting or investors’ selling investments held in taxable accounts for the purpose of realizing long- or short-term capital losses. Investors ditching their losing

Tis the season of tax-loss harvesting or investors’ selling investments held in taxable accounts for the purpose of realizing long- or short-term capital losses. Investors ditching their losing assets in advance of January 1 could help to reduce taxation on their overall income, a notion that looks especially enticing to those who have watched their portfolios tumble with the year’s volatility. Tax rates applied to long-term gains are for the time being, limited to 15 percent. Short-term gains, though, can be taxed as much as 35 percent, offering considerable incentive to investors feeling the pinch.

Tax-loss harvesting is often encouraged as a means of recouping at least some of the losses on a portfolio. It can be expected to be especially prevalent this year as many have watched their holdings tumble with no sense of when or if they’ll recover. The S&P has plunged 5 percent this year, providing a multitude of opportunities for investors looking to shed losers upgrade to better holdings. The direction of the global economy, with the burden of the debt situation in Europe and near flat U.S. global growth rate, is tenuous to say the least. Many traders doubt whether their stocks will even have a fighting chance at recouping losses in the coming year as the problems plaguing the market this year do not seem to have abated.

Among the biggest losers in this scenario may be financial stocks. The big banks have been subject to enormous volatility throughout the year as the housing and job markets remain stunted and some exposure to Europe’s debt crisis caused a sell off. This week has been a strong one for stocks, the best since 2008 and financials were no exception. Banks rose more than 5 percent on November 30 and many investors may be tempted to take the money and run as the end of the year approaches. Shares of Bank of America (BAC) added over 9 percent in the 5-day-period while Citigroup (C) tacked on just under 20 percent. With this sort of optimism and the market’s volatility this year, next week could see those trends reversing themselves as traders attempt to lose as minimally as possible while still benefitting from the advantages of tax harvesting. Analyst assessments on banking stocks remain mixed. While there is some consensus on the fact banks are on sale, the threat of a deeper discount in 2012 looms alongside a dangerously low U.S. growth rate and heightened scrutiny. Some investors are choosing to avoid the risk.

The same can be said for energy stocks which, in rough years, tend to be among the first stocks sold come tax harvest season. When the economy is weak, the price of energy stocks tends to directly reflect that. There is some security in the fact that global energy use continues to rise, but that is not enough to comfort a percentage of investors cognizant of the struggles that could keep prices low in the short term. Those strapped for cash may not want to wait it out. Depending on the approach, this could be a good or bad thing.

Chen Linn, the author of What is Chen Buying, What is Chen Selling, recently discussed this in an interview in Business Insider.

“Generally, the oil market bottoms in the winter and then goes up in spring all the way to summer. So, we’re coming to a very strong part of the seasonal oil price cycle,” he said, in reference to the more bullish approach to tax-loss harvesting peaks. If investors choose to cut their losses and exit the market instead of adopting the bargain bin approach they should do it immediately.

“Selling late puts an investor in competition with many others who are doing the same thing. That could result in a lower price than they would otherwise get,” according to a recent piece in Smart Money. The article goes on to discuss the potential risks of delaying the sell. “ A basic human tendency called loss aversion makes investors want to ride out a paper loss as long as possible in hopes the stock will turn around, even though the economic benefits of that strategy are dubious.”

In order to asses the greatest risk, the Wall Street Journal highlighted the financial stocks with the steepest year-to-date losses, according to the KBW report.  Hovnanian Enterprises (HOV), Suffolk Bancorp (SUBK), First Financial Service (FCFS) topped the list, followed by Bank of America (BAC) and Life Partners Holdings (LPHI).