Beating The Rush

By Daniel Kadlec

Here's some bad news for anyone sitting on a stock that got hammered as the market fell this summer: your bright little idea may get pounded even more this fall as fellow shareholders sell to lock in tax advantages by year's end. Tough out there, huh? By acting now, though, you can turn the expected "tax-loss selling" into an opportunity. There are some extra risks and costs, but they don't amount to much if you have losers that you expect to sell anyway. The basic strategy is to dump your dogs now, so that when the crowd starts doing it in November, you'll be waiting with a leash, ready to grab the picks of the litter.

Obviously, nothing is that simple. Your losers might shoot much higher by year's end, in which case you would have been better off holding on to them. And no investment decision should be governed strictly by taxes. But if you plan to sell and are just waiting for a higher price, look out. This has been the toughest year for stocks since 1994. The major averages are up for the year, but thousands of stocks are well below their highs, and dozens of aggressive-growth stock funds are showing losses. All of them are candidates to be sold down even further so that investors can realize their losses to offset gains.

Ordinarily, tax-loss selling occurs in November and early December, and very often that selling leads to a "Santa Claus rally" around Christmas, and then to the "January effect" as investors buy stocks that have been driven arbitrarily low. But in a year like this one, with widespread losses, it makes sense to start sooner. "The smart move is to think like it's November in September," says John Manley, market strategist at Salomon Smith Barney.

At my request, Manley screened for stocks that are down and may be driven even lower by tax selling. He found that there are 160 stocks traded on the three major exchanges--New York, American and NASDAQ--that are at least 25% below their average price over the previous 12 months. Note: that's not from their high point, but from their average price, a proxy for the price most people paid for the stock over that period. On the list are plenty of big, widely held companies, including oil-services giant Halliburton, tractor company Deere, Northwest Airlines and food-and-tobacco conglomerate RJR Nabisco.

These are vulnerable to tax-loss selling. Consider dumping them now. You'll realize a loss you are prepared to take anyway, but you'll give yourself the chance to buy the stock back for less later on, though you must wait 30 days or lose the tax break.

This isn't the dicey game of timing it may seem. For example, you can guard against missing a quick recovery by buying another depressed stock in the same industry. Sell Halliburton, down 41%, to lock in the tax benefits; then buy rival Schlumberger, down about 30%. Likewise, swap Philip Morris for RJR, AMR for Northwest, Caterpillar for Deere.

Even without that protection, though, the tax breaks give you a cushion. If a stock falls from $100 to $60, that loss is worth $8 in reduced taxes (based on a 20% capital-gains rate). Thus you could buy the stock back at $68 and not be a penny worse off (excluding trading costs). And there's a bonus: you'd be out of the market in September, the only month since World War II in which the market, on average, has consistently fallen, and October, the crash month responsible for more heroic stumbles than Bill Clinton.

See time.com/personal for more on tax-based selling strategies. You can also e-mail Dan at kadlec@time.com