In an interview with CNBC the Oracle of Omaha disclosed that his investment vehicle (Berkshire Hathaway) is delaying taking profits in anticipation of a tax cut.
Right now we’re sitting and watching because within three months, actually less than that, we’ll know the answer on it . . . I would feel kind of silly if I realized $1 billion worth of gains and paid $350 million in tax on it if I just waited a few months and would have paid $250 million.
No one is faulting Mr. Buffett for his investment acumen but his willingness to let taxes be the tail that wags the dog is reminiscent of the same mistake novice investors (i.e. speculators) made in the late 1990s prior to the bursting of the dot-com bubble.
Let’s take a look at Mr. Buffett’s math:
On an assumed $2 billion portfolio with $1 billion cost basis he could take $1 billion in profit. At the current 35% tax rate he nets $650 million. If he waits to sell until Jan 1st and the tax rate is cut to 25% in 2018 then he nets $750 million. Good thinking, right?
Here’s the fly in the ointment:
There’s no guarantee the $1 billion in profits today will still exist on Jan 1st. Those are unrealized profits. If the $2 billion portfolio declines 6.7% over the next 3 months then he’d better get that tax cut just to break even. A pullback of this magnitude will leave him with the same $650 million as if he’d sold today at current rates. Bird in the hand!
NO TAX CUT: $2 billion – $1 billion = $1 billion – 35% = $650 million
TAX CUT (6.7% selloff): $2 billion – 6.7% = $1.86 billion – $1 billion = $866.66 million – 25% = $650 million
This type of thinking got lots of folks in trouble in the late 1990s. ‘Investors’ in CompanyWithNoEarnings.com, eToenails.com and UnexplainableBusinessModel.com watched as stock prices doubled seemingly every couple of weeks. Even ‘tried and true’ companies like Cisco, Nortel, Lucent, etc. saw massive price spikes.
Smart money took profits. Dumb money held out for tax cuts and the clock to tick to turn ST gains into LT gains . . . and while they waited stock prices collapsed. Many people saw the value of their investments cut in half. Sometimes more.
LT capital gains tax rates in the late 1990s were 28% heading down to 20%. Folks holding out to save that 8% tax lost 50%+ of their profits when the prices of the stocks they held collapsed. Was hoping stock prices held up to save a few dollars in tax worth the risk?
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