Spring Cleaning

Sanjib Saha

AS THE STOCK MARKET repeatedly hit new highs in recent years, my net worth reached levels I hadn’t expected. But instead of feeling good about it, I was getting annoyed. Most of my retirement dollars had been invested over the past decade at high stock market valuations. I could use a good bear market so that, in my few remaining years in the workforce, I bought stocks cheap.

I also worried that a prolonged downturn at the worst possible time might derail my early retirement plans. Indeed, the bull seemed unstoppable even a month ago. But the coronavirus has ended my wait.

The bull market’s demise hasn’t just been a psychological relief. It’s also allowed me to get my financial house in better order. I’ve been busy executing trades I’d planned for whenever a market plunge might occur.

What trades have I made? My investments needed a spring cleaning, so that’s where I started. Although I mostly invest in low-cost, broadly diversified index funds, a small portion of my taxable account was in a few narrower funds focused on technology, small-cap and value stocks. My original intent was to overweight some promising stock market asset classes, but I’ve come to realize they didn’t add much to my portfolio. Problem is, these holdings had climbed in value and I was reluctant to sell, because of the taxes it would trigger.

The market plunge changed that, allowing me to sell without generating big tax bills. I also took tax losses in a few other funds focused on dividend-oriented stocks and international markets, where I wanted to keep my exposure. I used the proceeds to purchase similar—but not substantially identical—funds. This allowed me to maintain my market exposure, while sidestepping the wash-sale rule.

With these trades out of the way, I turned my focus to my next task. Some background: I had set aside a small portion of my bond investments to switch to real estate investment trusts (REITs) at a future time, when the risk premium was more compelling. This move would increase my portfolio income in today’s low-yield world. I already had REIT investments through low-cost exchange-traded index funds. For a change, I was open to adding a time-tested, actively managed fund to the mix.

My preference was a closed-end fund (CEF). Why? Compared to regular mutual funds, CEFs have unique characteristics, making them attractive to income seekers. CEF managers don’t have to worry about paying off redeeming shareholders, so they have the freedom to make illiquid, longer-term investments. By contrast, a regular mutual fund may have to liquidate investments at an unfavorable time to meet investor redemptions.

This doesn’t mean CEF investors are stuck with their investments. CEF shares can be bought and sold on the stock market. This secondary market trading often causes the share price of a CEF to deviate from its net asset value, or NAV, which is the value of the fund’s holdings figured on a per-share basis. If investors buy a CEF at a discount to its NAV, that means their yield is higher than the yield on the CEF’s holdings.

CEFs often use a limited amount of leverage to boost their return. This leverage increases a fund’s expenses, because of the interest cost involved. It also makes the fund riskier. But I’m comfortable with the leverage, because it’s frequently used with real estate investments.

I researched funds such as Nuveen Real Estate Income (JRS), Cohen & Steers Quality Income Realty (RQI) and Cohen & Steers Total Return Realty (RFI). The fund I eventually settled on had survived the 2008 bear market and, over nearly two decades of existence, had often traded at a discount.

But when should I pull the trigger? The recent market plunge created the opportunity I was looking for. First, REITs were selling at a low price, pulling down the fund’s NAV. Second, my chosen CEF’s typical discount already meant it was a bargain—but the panic selling increased the discount even further. That was the icing on the cake.

Once that trade was completed, it was time to step back and review my overall asset allocation. Sharp market increases and deep plunges are both opportunities for one-off portfolio rebalancing. But I also realized that, although the market has dropped quickly, the magnitude of the decline isn’t that big a deal: At this point, we’ve simply given up the gains made in 2019. I moved some of my bond-market money to stocks, to bring my portfolio back into line with my target percentages, but I haven’t opted to overweight stocks—yet.

A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Working the PlansGot Gold and Risky Option. Self-taught in investments, Sanjib passed the Series 65 licensing exam as a non-industry candidate. He’s passionate about raising financial literacy and enjoys helping others with their finances.

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Langston Holland
Langston Holland
1 year ago

I love the rigor of your articles Sanjib, thanks. Also, the link you provided to the Forbes article on wash sales is the best I’ve seen on the topic.

David J. Kupstas
David J. Kupstas
1 year ago

How are you better off selling those narrowly focused funds at a lower value vs. at a higher value? If I buy a fund at $50 and it goes to $90 and I sell, I made $40 which I’m taxed on. If it goes down to $70 and I sell, I made $20 which I’m taxed on. I’m thinking I prefer the $40 over the $20, even though it’s taxable gain. As for tax loss harvesting, I am trying to figure out how to make this work for me. I have a loss on an international fund. If I sell it now and harvest the losses, I have to hope the value stays depressed for 30 days before I can buy it back again. Even so, now my cost basis is low, so I will eventually have a higher taxable realized gain when I sell it. The only way I can see this making sense for me is if I donate that fund to charity down the road.

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