Cost Benefit Analysis – worked example

Making a financial investment decision is (or should largely be) a review of the greatest benefit given your target goal and strategy. But there are occasions that you just have to sell a holding and have a choice as to which wrapper it is in as to the greatest personal benefit.

This is one such occasion. I have drawn down my ‘loose change’ so to speak and had planned to do a SIPP Drawdown in April of this year and start taking a monthly pension out. Problem is, old Vlad the muppet has decided to be a bad boy and cause mayhem. So I have a choice to make as to where to draw the money out from.

I have a particular holding held across 3 vehicles (large holding of a Vanadium stock [Bushveld Minerals]). Lots of reasons why the SP is languishing where it is and so clearly undervalued, lots of reasons to see a 3-5x move from current levels over the next 12-18 months. Not going into that .. the issue around its value is not relevant to making the choice.

I want to draw out (NET) a sum, lets say £12k, to pay some bills over the period of mayhem and I have 3 choices

1. Take the money out of Trading account
2. Take the money out of my ISA
3. Take the money out of my SIPP

Now intuitively, I sell more shares using a SIPP as that is subject to income tax at 20% (in my current case). The Trading account sale would be at a trading loss, so no tax to pay, and no taxes on ISA transactions. But no-one like to make a loss !

Current SP (as I speak) is 9.3 so will use that and ignoring transaction charges just for simplicity (they are relatively tiny anyway), the way we look at overall benefit is to detail the numbers.

…. all of them !

So to show the process, I will say I want a NET sum of £12,000

Case 1 – Trading Account

At 9.3p that equates to 129,033 shares. Original purchase price was 15.58. This equates to a bankable loss of (6.3p) per share equating to a loss of (£8,105).

Wow .. no one like a loss.. but there is a benefit to the loss as we shall see. Remember.. I have to realise a NET amount regardless of the market right now. The question is what is the best overall position I can be in. Note, this is not ‘how much profit can I make’. Investing is about outcomes and goals, and whilst long term profit is essential, it is only part of the overall story.

Not all doom and gloom as there is a benefit – I can make an extra £8,105 of profit in the future before I pay any tax (at 10%).

Case 2 – ISA

Same number of shares at 129,033, but in this case my average purchase price was 3.21 so clearly a profit of nearly £8k … happy days !

Case 3 – SIPP

Now I have to assume any sale is post tax allowance. Not only will it be a bit tricky to not do that, but the cold reality is that I will pay tax for other reasons.

So to get £12,000 NET paying 20%. but as I am running a drawdown even, 25% of that is tax free. That means the first 25% of £12K is tax free, meaning my gross taxable will be (75%*£12K/0.8) = £11,250, added to the £3,000 tax free means I need to sell the equivalent of £14,250 to obtain an overall NET of £12,000.

At 9.3p that equates to 153,226 shares

So how do I review the costs vs benefits ?

A common mistake is to look at numbers as absolute at this one point in time. On that basis, selling the shares in my Trading Accounts might be the best option due to the bankable loss I can carry forward to offset future gains. The notional benefit is essentially the 10% tax I would not pay on that loss (if it were a profit), ie around £811. Not to be sniffed at as represents around 6.8% of the NET amount I need.

But a loss is a loss and unless I am really sure that loss would be made up in the future, then it clearly wont be the right option.

But as I indicated, my longer term exception is the SP moves north considerably. I did have (for a number of personal reasons) a target point of 25p to start selling down.

In the end, investment decisions are based on a mixture of what you know and what you believe !!

So to look at where my best longer term benefit comes from, I need to consider the ‘what-if’ of both selling and not selling in each to consider the overall best position against my sell strategy.

First step … look at the net benefit of selling each

Trading – 129,033 shares generating £12,000 + a future tax benefit on the loss of £811 giving a total of £12,811

ISA – 129,033 shares generating £12,000

SIPP – 153,226 shares generating £12,000 (NET)

 

Next … look at the net benefit of holding each to my target of 25p

 

Trading –  129,033 shares generating a profit of £12,152 (ie sale less cost) less a 10% tax of (1,215) giving £31,043

ISA – 129,033 shares generating £32,258

SIPP – 153,226 shares generating a gross of £38,308 and net after 25% tax free and 20% income tax of £32,560

 

Now to work out the overall Benefit.

 

Case 1 – Sell Trading + keep ISA + Keep SIPP = £12,811 + £32,258 + £32,560 => £77,629

Case 2 – Sell ISA + Keep Trading + Keep SIPP = £12,000 + £31,043 + £32,560 => £75,603

Case 3 – Sell SIPP + Keep Trading + Keep ISA = £12,000 + £31,043 + £32,258 => £75,301

So whilst selling my ISA or SIPP are essentially the same outcome, clearly selling my trading account shares AT A BIG CURRENT LOSS generates the best long term outcome….. around 3.1% better off.

But what if the SP target is not achieved and I need to sell against my sell-down plan anyway. Well, plotting the various numbers, in all cases, there is a material benefit to selling my Trading account holdings first (even at a loss).

This graph shows the benefit of selling from Trading, ISA or SIPP vs not selling.Sale price is 9.3p and the bottom axis plots the future target sale price all the way from lower than today up to 3x

SIPP is always the lowest value (hence a benefit of 0%) and essentially selling ISA first is practically the same as SIPP (hardly a surprise when considering the way the tax system works). It is selling from the trading account that is the clear winner with a steady and linear benefit against future target sell price.

Whilst the increase in benefit is linear, the rate of future benefit diminishes. Rather looks like my target future price of 25 is about the best place (funny old world !)

Cost-Benefit Analysis is not always about the maximum possible value, but sometimes the least worst option.

A loss made is not the relevant question if you have to ‘sell’- it is about the big-picture value overall

 

 

 

 

 

 

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