For Immediate Release

For More Information Contact:

Kevin M. McGonigle, EVP
CornerCap Investment Counsel
Phone: 404-870-0700
Fax: 404-870-0770
E-mail: kmcgonigle@cornercap.com

CornerCap Investment Counsel
Offers Alternative Consideration
To Year-End Tax Loss Selling

ATLANTA – (Jan. 16, 2008) – Editor’s Note: The following article was written by Douglas M. Dougherty, CFA, a vice president and portfolio manager with Atlanta-based CornerCap Investment Counsel.

Offsetting the year’s investment gains by liquidating losing positions (“tax loss selling”) is a widely advocated tax-saving strategy at year-end.

But is this a wise investment strategy?

If taxable gains for the current tax year have been realized, it is indeed tax-efficient to offset those gains throughout the year by selling losing stocks that no longer meet one’s investment criteria.

However, the phrases “throughout the year” and “no longer meet one’s investment criteria” are the keys that most tax professionals and investment advisors overlook.

Challenging the Sacred Cow

If a stock still fulfills the risk/reward profile of your investment strategy, why would you sell it?

And if the stock no longer meets your investment criteria, why wait until year-end to sell?

Most tax advisors advocate selling a losing position at year-end to realize the tax loss and then buy back the position 31 days later. In order to recognize a loss for tax purposes, the IRS requires that the security whose sale generated the loss not be repurchased by the seller for a minimum of 30 days; otherwise, the transaction is considered a “wash sale” and the loss is disallowed. This year-end selling strategy produces offsets to realized gains, resulting in current-year tax savings.

However, from an investment viewpoint, here’s the problem: you are selling the same securities at precisely the same time as everyone else. Virtually everyone who owns a losing stock in a taxable account is receiving exactly the same advice from his tax advisor at the year-end: sell.

As this flood of sellers enters the market in December, the natural supply-and-demand balance for this security becomes distorted, resulting in further price declines to an already depressed stock.

One is almost guaranteed to receive a less-than-fair price for his investment, and the execution of this transaction goes against the basic key to successful investing: buy low, sell high.

The January Effect

In fact, the “January effect,” whereby stocks tend to exhibit sharp price appreciation at the beginning of the year, is the result of indiscriminate year-end tax-loss selling. Because such selling depresses the stocks but has nothing to do with their fundamental worth, bargain hunters quickly buy in, causing the January rally.

Unfortunately for 2008, there has been no “January effect” as the significant market decline has kept most bargain hunters on the sidelines.

Many investors who follow the traditional tax-saving advice and sell out at year-end fully intend to repurchase the stock in 31 days.

But what typically happens is that the investor has now associated the purchase of this stock with the realized loss – in other words, a negative mental reinforcement – and the stock is not repurchased.

Also, the “out of sight, out of mind” phenomenon sets in, and the bad feelings are soon forgotten.

In such instances, the seller “loses” twice, both from an economical and a psychological point of view.

Economically, money was lost on the investment, even though the investor may view the very visible and immediate cash savings on his tax return as a benefit.

Psychologically, by selling the stock at a loss, there is the tacit admission that the purchase decision or timing was wrong. It may be that the timing of the buy was “early,” but unfortunately in the investment arena, it is hard to distinguish between “early” and “wrong.”

Aside from bad feelings, what is the real harm in allowing one’s investment discipline to be compromised by tax considerations?

Tax-Loss Selling Quantified

CornerCap manages several accounts for clients who have demanded aggressive tax-loss selling at year-end. To quantify the effects of year-end tax-loss selling, CornerCap measured the performance of the largest of these portfolios over a 10-year period.

When compared to the results of another portfolio of similar size with identical investment objectives and similar holdings but with no requirement for tax-loss selling, we found that the negative impact of the traditional year-end tax-loss selling on investment performance was more than 1.5 percent per year.

Assuming a $10 million beginning portfolio value, this would equate to a loss of $4.85 million over the 10 years.

To avoid selling your losers along with all of the other “losers” at year-end, why not consider an alternate strategy to achieve the same tax efficiency but with improved investment results?

For example, consider selling holdings with losses that no longer fulfill your investment criteria throughout the year—and certainly before the closing weeks of December.

By doing this, the investor avoids selling with the herd and stands a much greater probability of receiving a fair price.

Harvesting losses from key holdings throughout the year can be another tax efficient investment strategy. This is accomplished by purchasing a duplicate position of the holding (this is only applicable for stocks that continue to meet one’s investment criteria) and then selling the original (i.e., losing) tax lot 31 days later.

In this fashion, you have remained faithful to your investment philosophy, will capture any potential upside, and have “harvested” the tax benefit.

At CornerCap, we are certainly sensitive to taxes. Like commissions and trading spreads, taxes are a cost of successful investing. Taxes on short-term capital gains are particularly onerous and should be avoided or offset when possible.

However, CornerCap believes that investments and not taxes should be the driver. Do not fall victim to allowing the very visible, immediate tax savings to negate the less visible longer term investment performance.

Your tax professional strives to reduce your taxes each year. CornerCap, on the other hand, strives to maximize after-tax investment results over the long-term.

Perhaps this contrarian philosophy will help you to understand better how the importance of balancing tax management with investment management will result in greater after-tax assets.

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