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A Capital Gainsay

By, 11/12/2007

Story Highlights

  • Media headlines are already warning of higher tax rates after the 2008 elections.
  • It's far too early to know what the outcome of the elections will be, or what the incoming administration's agenda will be.
  • There's currently little benefit to trying to maneuver around potentially higher capital gains rates.

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Though our political pals have already been campaigning for, seemingly, an eternity, we're now entering the official campaign season. Hoorah! And the most popular agenda item, after ensuring the survival of blood-thirsty, man-eating Arctic carnivores, seems to be whether to extend or end the "Bush tax cuts."

The market doesn't care if the president's Democrat or Republican, and we don't either. At MarketMinder, we're vigorously politically agnostic, preferring no political action to any political agenda—left, right, or center. But should the Dems sweep the White House and Congress in 2009, are tax hikes guaranteed? And does that mean you should sell now to take advantage of today's lower capital gains rates? No and no.

First, the Dems are by no means guaranteed the White House. It's way too early to handicap the race. Recall Howard Dean seemed unstoppable before his barbaric yawp in Iowa. A million things could happen between now and November ‘08. Governors Romney or Richardson could make a surge. A major candidate could drop out of the race. Senator McCain could seize the lead from Mayor Giuliani, switch parties, and convince Stephen Colbert to be his running mate. Senator Obama could be discovered to have been Hillary Clinton's commodities broker! Voters could realize Hillary Clinton is Hillary Clinton!

If that provides no comfort, consider this: Would it shock you if the next president is a Democrat, and would it shock you if he or she raised the capital gains rate? Did you answer "no" to both? The next president won't take office for 13 months, yet we're already seeing headlines like these:

Wall Street Braces for Higher Tax Rates
By Jeanne Sahadi, CNNMoney.com
http://money.cnn.com/2007/11/07/pf/taxes/investment_rate_change_effect/index.htm?postversion=2007110815

The market doesn't move on what's widely expected—it moves on economic fundamentals that are unexpected. By the time President Whoever enacts their stupid tax agenda, the market will have had a very long time to price in the ill effects. That doesn't mean we think tax hikes are no big deal—it means you needn't worry about what pretty much everyone is already worried about. There's not much market moving power in the wholly expected.

But let's suppose you know exactly who'll win and exactly what's in their black little heart—raising the capital gains rates to 25%. Or higher! What can you do with that information?

Some might say, "Sell! Sell! Sell!" to take advantage of today's lower capital gains rate. Fine . . . then what? Sit with your proceeds in cash? Even assuming a tax hike, equities have a far superior long-term average than bonds or cash. Selling now to avoid a higher rate later isn't cutting off your nose to spite your face—it's full frontal lobotomy!

Another straw man might say, "Well, I'll sell now to pay the lower rate, then reinvest. That'd be smart, right?" Nope—if you assume stocks generally rise over time (as we do), the best place for your dough usually is in stocks. Trying to time the market, no matter what your reason, is fraught with peril.

Plus, it's not guaranteed you'd be better off by gaming the lower rate now. The magic of compounding means it's generally better to leave money working in the market for as long as possible. Why pay taxes now if you don't have to? Yes, your rate might be higher later, but it's a higher rate on conceivably a much bigger pool of assets—meaning if you give the market time, you can still end up with more, net-of-taxes, than if you do a tax hokey-pokey now. Isn't the goal to end up with more money? We're not fond of handing our money to the government either, but we wouldn't purposely deprive ourselves of greater returns just to make a point. We're principled, but we're not crazy.

We can't know how the elections will turn out, and there's no telling what the incoming administration's tax policy will be. Anything can happen—we can even envision a situation where a Democratic sweep of both Congress and the White House still wouldn't yield higher taxes! Given those uncertainties, and the undeniable benefit of compounding interest, the best course of action is to deny the government tax revenue today in return for the likelihood of greater returns for yourself in the future. It's the American way.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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