It is fair to say that taxes are, in general, not popular. Most people would rather not have to pay over and above what they already do in the more unavoidable ones, like income tax. Capital gains tax (‘CGT’) is 60 years old this year, and in that time, has had many different rates and a number of reliefs, allowances and rebasements. Today, the rate is 24% for higher rate taxpayers and 18% for basic rate taxpayers, and the annual exemption allowance is £3,000 - as low as it has been since 1981.  

While the current rate is not especially high historically, the very low level of allowance and lack of other reliefs pose the question: what should an investor’s approach to CGT be? 

As a gain is only liable for CGT when an investment is sold, the investor always has the option not to sell. In the long run, a ‘buy and hold’ strategy can be very profitable. However, it does bring the risk of added volatility if a manager does not trim a position in a portfolio that has either become too large or too expensive.  

The reality is that most investors cannot simply ‘buy and hold’. Sales may be needed to release capital to meet short-term needs, such as supplementing income, paying for school fees, or to provide a deposit for a house. It is impossible, therefore, to avoid CGT liabilities forever.   

It is worth remembering that CGT is a winner’s tax. You only pay it on the proceeds from the sale of an investment that has done well – galling though that might be. 

Yet, it is also worth bearing in mind that every single investor makes investments that will eventually lose money. We try to ensure that this is because of ‘unknown unknowns’ rather than ‘known unknowns’—as Donald Rumsfeld would have said—but it is a fact.   

If investors generally do not like paying taxes, neither do they like crystallising losses. In Daniel Kahneman’s Nobel Prize-winning ‘Prospect Theory’, he and fellow psychologist Amos Tversky demonstrated that investors feel losses quantifiably more than gains. The resulting ‘loss aversion’ is a bias that can lead to investors holding on to poor-performing stocks for longer than they should.  

However, for CGT purposes, losses are offset against gains, so ‘tax aversion’ is one way to overcome ‘loss aversion’.  

Yet even then, we must be careful not to let ‘the tax tail wag the investment dog’. Or put simply - tax should not dictate our investment decisions. It can be a consideration, but other factors are more important in the long run. We believe that active management is the route to better risk-adjusted returns. By taking profits when an investment appears expensive, and reinvesting when cheap, we aim to not only improve returns but lower volatility. 

Attitude to tax is a personal thing. As active managers we can try and mitigate tax liabilities, but, in the end, if we feel that there are better opportunities elsewhere to deliver better returns, then that should be our primary aim. 

Important Information

The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment arrangements. Please note, we are not tax experts, and you should seek professional advice concerning your personal tax affairs from qualified advisers, such as tax accountants.

Please also note that the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.