MFI & Taxes

I was thinking this morning about taxes. A topic on my mind of late. Greenblatt has set up his MFI approach to take advantage of the tax code. You sell your losers just before a year and thus get to deduct your losses at your marginal income tax rate (say 35%) and you hold your winners >1 year and thus pay LT capital gain taxes of 15%. The net of these two is less than a 15% tax rate. Meanwhile, the benchmark doesn't pay taxes until you begin withdrawing money. But then that will be at a 15% rate.

Which is preferable? To have your taxes deferred (as per the benchmark) or to pay a lower net rate? Heck, that is why spreadsheets were invented.

Let us take a simple example. You own 7 stocks. One goes down 20%, one down 10%, then the other five are flat, +10%, +20%, +30% and +40%. You have $1,000 in each. At the end of a year you have $7,700. Your taxes are $45. If you have bought a benchmark and it went up by 10%, you'd owe $105. Clearly if you sold both sets after one year you're better off in MFI.

Now suppose you hold the benchmark for 5 years while you keep re-investing in the MFI portfolio. Your benchmark would be worth 11,273. You would owe $641 in taxes and would net 10,632. With MFI (ignoring commission costs) growing to 10,946 (after taxes). Wow, I think it is clear that you're better off tax wise with MFI even if it does the same as a benchmark.

I looked at my MFI portfolio and if you did it after tax I'd be just a whisker (instead of 1.5%) behind the benchmark. Of course it is all hypothetical and some of my MFI is in IRA account which doesn't have LT capital gain taxes. This whole train of thought makes me wonder whether MFI is better served outside an IRA (if you had a choice). It also depends on whether you have a Roth IRA (I do not)... but I digress.

Just a slow day, up about a quarter of a percent. PNCL was my top performer and is now up like 53%. I wonder if all the people on the MFI board who said they would not touch an airline stock are gnashing their teeth?

I am doing a little gnashing as well. I am having serious seller's remorse. CLE went up about 4% today. AH it was up to about 35. I sold at about $31 (I think). Errrr $4 more per share would be, let us see... carry the five.... gnash, gnash, gnash. I should have just made CLE an MFI stock. Faithful readers take note. When JG annoints a stock, buy it and hold it for a year. My other gnashing is PCU. I sold it as I had held it a year, though it had been grandfathered into my MFI portfolio last February. I sold it just shy of $50. It is now north of $57 and I think there may have been a dividend as well. Okay, okay... I believe. I am not selling anything before its time. (It should be noted that I essentially bought ASEI with the PCU proceeds and that is up about 45%).

Warning - Warning: Gloating Ahead!

again, a little off-topic. I am so happy about my purchase of Devon Energy this fall (DVN). In August they were trading at about $65. They were part of the announcement of the deepwater oil find in the Gulf that is expected to be the biggest oil reserve for the US outside of Alaska. That one find boosted DVN's proven reserves by 42%! What did the stock market do? DVN immediately shot up10% around $71. Then oil prices dropped and DVN droppped. I waited and jumped in at the bargain price of $59.20! I could not believe my good fortune... like finding money on the sidewalk. 42% more oil and the price had dropped 10% from the day it was announced. Geesh! Anyway DVN is back to $71. Today they announced that they have found even more (Anadarko, Devon Make Deep Water Discovery). Pardon me while I do a jig!