A POPULAR REFRAIN is that we shouldn’t let the tax tail wag the investment dog. I struggle with this one.
Currently, 87% of our stock portfolio is in broad-based, low-cost index mutual funds, with the other 13% in individual stocks. I prefer the index funds—and yet I continue to hold the individual stocks because I don’t want to pay the taxes on our gains.
About 6.7% of our total stock portfolio, equal to half our money in individual stocks, is in my former employer’s shares, which I received as part of my compensation. Over the years, I’ve worked diligently to keep our holdings below 10%.
Our next largest individual holding is Target Corp., at about 2.8%. When my wife picked me up from work on Oct. 19, 1987, all of the news was about the stock market. The Dow Jones Industrial Average had crashed 22.6%. On the drive home, I asked my wife what she thought we should do. She promptly replied, “Buy Dayton Hudson.”
Dayton Hudson was our local department store. Its major division was its Target discount stores. Being a young couple, we shopped at Target, so the next day I bought 100 shares of Dayton Hudson. The department stores are long gone, but Target lives on.
Between our initial purchase and reinvested dividends, our cost basis is now $13.80 a share. Yesterday’s closing price was $149.36 (symbol: TGT), almost an 11-fold increase. Although I’d like to unload the stock and put the money in an index fund, the thought of paying the taxes—even at the long-term capital gains rate—has kept us from selling.
Our third largest holding is McDonald’s, representing about 2.5% of our portfolio. In late 1981, I bought a single share of McDonald’s and enrolled in its dividend reinvestment plan. That gave me the ability not only to reinvest the dividends in additional shares, but also to send McDonald’s money to buy more stock. For many years, I purchased $50 of McDonald’s stock every quarter. As my salary grew, the amount I invested also grew, eventually reaching $150 a quarter. Our cost basis today is the equivalent of $51.80 a share. Yesterday’s close was $252.42 (MCD), almost a fivefold increase. Again, I have a hard time selling the shares and paying the long-term capital gains taxes.
We own three other individual stocks, each less than 1% of our assets, but each showing nice gains. So, what am I doing?
I sold some of my employer’s shares that were showing a loss. I also sold all of our Novartis stock, which had “only” doubled in price. The loss offset the gains, so the trades didn’t increase our tax bill. I’ll use the proceeds from the sales to buy more of our index funds. That’s a small step toward eliminating the individual stocks in our portfolio.
I’m not sure that I’ll ever sell the Target and McDonald’s shares, and trigger long-term capital gains taxes. My plan right now is to die holding them, and let my children inherit them at a stepped-up basis. They can then sell them and invest the proceeds in a well-diversified portfolio.