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Author: BuildMWell Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 41614  
Subject: Capital Gains Taxes Date: 6/22/2004 8:03 PM
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I just ran across a post from another board that I wrote concerning the BMW Method. It is a comparison of buying Johnson and Johnson (JNJ) using the BMW Method versus just buying and holding the stock. It is based totally on what I observed with JNJ...the numbers of shares are hypothetical...not my actual number of shares. But, the math is the same per share if you break it down that way.

Here is what I said back then:

If I could give out any one piece of advice, it would be, "Never let the worry of capital gains taxation keep you from taking a solid gain and pocketing the money. Taking your gains, holding cash for a while and buying a stock back at a significantly lower price later is never a mistake."

That is the hardest investing lesson that I have had to learn. All we do with holding an equity long-term is to limit our potential and delay the tax consequences. However, in my opinion, the tax consequences will only get worse with time. I prefer to pay them now and know that the money in my account belongs to me! That way, Uncle Sam has no claim to a huge capital gain anytime in the future.

Sooner or later the taxes will be have to be paid...the only question is, "What tax rate will you be taxed at?" The lower the rate the better in my book. If you have a fairly low taxable income now...this is the time to use that low tax rate to your advantage. Pay the tax now...take some profits. The desire of most people to not pay taxes is the biggest trap in taxation. Many folks end up at age 70 with huge capital gains that keep them from diversifying because they refused to take some profits much earlier, raise up their basis and diversify when the price was right.

In my JNJ example, if you bought in 1994 and sold in 2000, you had a 35% capital gain per year. If you owned 1000 shares at $9/share and sold at $54/share, you had a gain of $45,000. At a 20% Cap gain rate, you would have given back $9000 plus the state tax. But, you would have had the original $9K plus the $36K to reinvest. As it turned out, you could have bought 1300 shares 6 months later. What you would have gained is 300 shares (30%) in the number of shares PLUS you would owe no tax. I call this phenominum, "Gaining on it."

Selling those 1300 shares in 2002 at $64/share gets you $83,200 but you owe tax on $37,000. You pay the tax and keep $30,160 plus your $45,000 that has already been taxed. Your original $9000 is now worth $75,000 and you owe no tax. That is your money! That is a 30% return on your money AFTER taxes.

If you had bought and held JNJ, your original $9000 would still be worth $64,000 in 2002...a total return of 27.8% BUT you would still owe the tax. You now have succeeeded in putting the government in your wallet! You think you have a gain but they own a big chunk of it still. After taxes, you actually have $11,000 less than you think and you are trapped! So, you just hold your 1000 JNJ stock and ride it down to $42/share. Why?

The 15% capital gains rate is a blessing! The way I do things, my gains are always long-term. But, I love paying those taxes! Well, that ain't exactly true. I wish that there were no taxes to pay...but since we have to pay eventually, I love paying the lowest tax rate possible.

Plus, this is how I eat. This is all that I do for a living. I have to take some gains and pay the taxes so that I have income to live on. Day trading would be a full time job. I prefer being much lazier than that. I trade maybe six times each year.

Ten years ago, I figured this all out. I realized that I was worth more to myself than I was to any business. I have been getting nice raises every year since I quit my job. That is how I have the time to follow so many companies. The way I look at it, I have some of those businesses working for me. I have no problem with laying them off when they get too expensive. They would do the same with me, wouldn't they? Turnabout is fair play.
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