Will We Be Forced to Work Until Death?

You ask if it's possible you could lose everything if you stay invested in the stock market over the next three to five years. The honest answer is "I don't know," given that I don't know the details of your portfolio.

If you're invested in just a few individual company stocks, then yes, it's quite possible a portfolio could fall to zero. Imagine if your sole holdings consisted of U.S. automakers, a couple large banks and some struggling retailers. I can think of some companies in those categories that could see their stocks turn worthless.

Finally, you ask about tax deductions on investment losses. Yes, you can deduct losses on investments, but there are restrictions.

First, you can only deduct losses on assets held in a taxable account. Losses inside an IRA, 401(k) or other tax-advantaged retirement account are not deductible.

And even if the losing assets are held in a taxable account, the amount you can deduct is not unlimited. I won't go into all the details of deducting investment losses, but here are a few things to know.

Realize Your Investment Losses

To deduct a loss, you must first "realize the loss," meaning you have to sell the investment in question. Then you can use that realized loss to offset any gain in another investment that has been sold in the same tax year. There is no limit on the size of gain you can offset with a loss.

However, once you've fully utilized your losses to offset gains, then your deduction on remaining losses is limited to $3,000 per year and you carry over additional losses to future tax years. That means if you have a $5,000 loss after offsetting gains, then you can take a $3,000 deduction in one year and then take an additional $2,000 deduction in the following year.

One way to mitigate the investment losses suffered this year is to sell a money-losing asset in order to capture that $3,000 deduction and then reinvest the proceeds in a similar investment. But be careful not to violate what's called the "wash sale" rule by buying the same or what the IRS calls a "substantially identical" security within 30 days before or after the sale.

For more information on deducting investment losses, consult IRS Publication 550, "Investment Income and Expenses," and see the section on capital gains and losses in Chapter 4. You can find the publication online at www.irs.gov.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com.

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