Let’s say an investor bought a dividend-paying stock three or four years ago that yielded 4%. Since then, the stock has appreciated in value and now only yields 2%. The investor is still getting paid, and the stock is still a good holding. How does the investor decide if and when he should sell?
To further illustrate this, let’s say you bought stock for $1,000. Today it is worth $10,000, but the dividend yield could be significantly lower than what is available in the marketplace. If you are earning 2% on $10,000, you have to consider if you sold the investment and paid the capital gains, you might only have $7,500 left. Could you find a stock of comparable quality and value that is yielding 4%? If yes, then you may consider selling and putting your investment into another company that is appreciating in value and growing their dividend.
In our low interest rate environment, it is extremely important for an investor to pay attention to their dividend-paying stocks. As wealth managers, we struggle with these decisions. The scenario above is not necessarily an indication you must sell, but it is something you have to consider and take into account in our current tax environment.
These are the decisions we have to consider when actively managing client portfolios. If we were to make sweeping changes, we have clients with considerable taxable gains. If you own shares of a mutual fund and the adviser makes sweeping portfolio changes, you may be forced to recognize gains you didn’t intend to recognize. With mutual funds, you never see the after-tax performance. While many funds attempt to manage their taxes, this is where individual stocks and an actively managed portfolio have an advantage. You can control when you recognize capital gains.
Let’s say your federal tax rate for qualified capital gains is 20%, and you pay 6% to the state and are subject to the 3.9% Medicare surtax on investment income. You could be paying close to 30% right off the top. Can you make up that 30% in a new investment? You may be able to through growth in value and dividend, but what if you only need income?
You may consider a utility known for consistently raising their dividend, where the stock price remains relatively stable. In this case, the dividend stock works better than a bond because the dividend can increase. However, you cannot have all of your money in one or two stocks. While we can appreciate a certain stock has made you a significant amount of money, we believe an investor should have no more than 10% in any one investment. We’ve seen very strong companies go through extended rough periods. Sometimes you have to sell your investments and recognize the capital gains. However in this tax environment, it is a decision that requires you to carefully weigh your options.
At Henssler Financial we believe you should Live Ready, and that includes understanding the tax consequences of your investment decisions. If you have questions regarding your financial situation the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at email@example.com.