Know when to hold 'em, fold 'em and avoid hefty tax slug

Just last week a friend rang to talk about her latest problem. And to be frank, it's the kind of "problem" that we would all like to have. She explained that 10 years ago she had invested $100,000 in CSL shares when they were just $10 a share. She has followed them religiously, was jubilant when they reached $114 in August 2016, and is now on tenterhooks with the price at $316 a share. The investment has increased tenfold in just 10 years - it is now worth over $1 million.

Her big decision now is whether to hold, sell, or take some profits.

I must point out that I have never owned CSL shares, and I have lost count of the times people have asked me if I thought they could go any higher.

My answer has always been, "I haven't got a clue," touched with regret I never got around to buying any. The price has always seemed too high - until you look back 12 months.

I pointed out to her that one of the basic rules of investing is that you don't get out of a good business.

Anybody who buys shares is becoming a part-owner of a business, and if that business prospers, they should do well over the long term. CSL revenues are now touching $US7 billion a year, and thanks to their policy of ploughing back profits into research, they still have good prospects.

It is also important when investing in shares not to get spooked by volatility. Because shares can be bought and sold quickly in small parcels, there are always transactions happening - when there is a spate of bad news and media such as the Trump "trade war" with China, or the coronavirus outbreak, the price of a share can tumble even though these events should make no difference to the company's profits.

This is why investors should hang in there for the long-term. Remember, if a business is a good business, it should be like a good marriage and bring you joy for many years to come.

Furthermore, if she cashed in the entire portfolio, there would be a big chunk of capital gains tax to pay and she would be faced with another risk: re-investment risk where the assets available to be bought with the proceeds of the sale are not as attractive as the assets you just got rid of.

But there is another option. That is to sell just enough of the CSL shares to get her initial stake back, and have the remainder riding for nothing. This should be coupled with a smart strategy to minimise capital gains tax.

In this case my friend is 54 and does not work, so if she cashed in $100,000 of CSL shares, the capital gain would be $90,000, and capital gains tax would be payable on $45,000 after application of the 50% discount. Add $10,000 of unfranked CSL dividend income, and her taxable income becomes $55,000.

She could then make a personal deductible contribution to superannuation of $25,000, which would reduce the taxable income to just $30,000, on which tax would be about $2200 once the various offsets are taken into account.

Total tax payable on the $100,000 sale would be $2200 plus the $3750 contributions tax on superannuation contribution. This is really a case of having her cake and eating it too.