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Averaging up & tax dynamics!


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Posted (edited)

Here’s a dynamic I hadn’t thought of before.

 

Please correct if I am wrong.

 

Example

Buy 100 shares at $100.

Total investment $10.000.

Price goes up a lot over time.

 

Valuation gets cheap and I invest another $10.000 and get 10 shares.

New price per share is $1000.

 

Previous average price per share: $100

New average price per share: $181.8

Total investment: $20.000

Total shares: 110 

 

Times passes and the price does another double to $2000 per share.

 

I go to sell the 10 shares I added.

 

Sell amount: 10*2000= $20.000

Amount invested: 10*181.8 = $1818 (shares sold*average price per share)

Profit: $18.182 (20.000-1.818)

Taxes at 40%: $7273

Money I can spend: 20.000-7.273 = $12.727

(So you invest 10K. It doubles. After tax you are left with 2.7K)

 

VS investing in a new company 

 

Invest 10k

Doubles to 20k

I sell and pay 4k in taxes

Money I can spend 16k

 

Other cons of adding to my position:

If I for whatever reason want to sell I can only do so while incurring tax payments.

Example: I sell the amount I added to the position for the same price, i.e. $10.000. But now I owe $3.273 in taxes. A disaster outcome really.

 

Even worse if I sell at a loss on my added-on position. I still owe taxes as oppose to a tax credit had it been a new position. 

 

I hadn’t given this much thought before. Seems important when you have big winners in your portfolio.

 

Just writing it down and wanted to share my observations.

 

Am I thinking about this the right way?

Edited by Aurelius
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Posted (edited)

In the first situation, you could sell just the second lot, reducing taxes in that situation given the much higher cost basis (or sell this lot and take capital loss if price declines while still holding first lot). But otherwise, comparing the first lot in situation one to the second situation, yes they are different since the capital gains are different. 

Edited by EBITDAg
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Posted (edited)

Interesting! 

So you can sell a specific lot?

Makes a lot of sense that you should be allowed to do that.

Otherwise it seems like a pretty bad deal to add to a position when you're up a lot.

 

I don't think that is possible where I live. @John Hjorth can you help here?

Edited by Aurelius
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12 minutes ago, Aurelius said:

Interesting! 

So you can sell a specific lot?

Makes a lot of sense that you should be allowed to do that.

Otherwise it seems like a pretty bad deal to add to a position when you're up a lot.

 

I don't think that is possible where I live. @John Hjorth can you help here?


Depending on your broker the process will be slightly different so just Google how to do edit your tax basis based on your broker.  It is typically done post trade so you’d have to sell first, then go in and edit which shares you want to sell.  You’ll get options such as FIFO, LIFO, and custom.  Select custom and manually select the shares.  Pretty easy process…at least on TD Ameritrade.

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Posted (edited)
Quote

In Canada, as far as I know, the cost basis is always the average purchase price of all shares owned.

Unfortunately, the same where I live. 

It's really rather unfortunate for the investor. And I don't see the benefit for the society either. How is it better that I invest in company B rather than company A? 

 

I have to assume it's because of less developed "investment culture". 

 

Oh well... 

Edited by Aurelius
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