Deferred Capital Gains Tax Is The Best Debt In The World
There’s absolutely nothing that tastes better than a deferred capital gains tax. Many investors consider investment loans as good debts because the interests are tax-deductible, but the deferred capital gains tax is even sweeter. Never mind tax-deductibility; it is interest-free!
If you double your $10,000 investment to $20,000, you owe Canada $2,000 in capital gains tax assuming you’re in the 40% tax bracket. (Only half of the capital gain is included in your taxable income.) By being a buy-and-hold investor, you defer the tax indefinitely until you liquidate the investment. Effectively, you’re borrowing money for free. The fruits of your patience also grow over time. Due to the compounding effect, the longer you hold the investment, the faster you accumulate interest-free debts.
The deferred capital gains tax is much friendlier than margin loans because it has no margin calls, so you’re not forced to sell a piece of good business at the cheapest possible price. Furthermore, the capital gains tax acts as your first line of defense during market setbacks; the government generously forgives the loan before you start to lose money. On the other hand, when you borrow money on margin, it is your equity that fortifies the lender. Market correction is not the time to be brave.
When you have an embedded capital gains tax in your investment, think hard before trading it with another investment. In the above example, such a swap will trigger a capital gains tax and shrink your capital by 10%. Think about what you’re giving up. You’re losing a layer of cushion that absorbs the price volatility, and you miss out on future compounding on the 10%.
In investing, it’s rare to uncover a value stock compelling enough for you to abandon 10% of your capital, and hope it will catch up to the stock you just sold. Note the difference; the 10% loss is guaranteed, while the new purchase is an educated guess, but still a guess.
If the government offers to subsidize your investment, don’t be rude. Accept the gift graciously by holding on to your investment. As Charlie Munger puts it:
Just sit on your ass!
You should also mention the corollary: don’t let the tax tail wag the investment dog. Taxes should always be secondary to the consideration that the investment still merits holding.
Congratulations on the Toronto Star mention.