Tax-Loss Harvesting: An All-Year Obligation, Not Just a Year-End Chore

By Robert J. Mascia, CFBS, Green Ridge Wealth Planning

When managing money, there are few guarantees, a lot of opinions and many truths. One impactful truth that can add tremendous value to investor portfolios is tax-loss harvesting, not just at the end of year, but as an all-year strategy. In bad years, money managers can help build up a war chest of losses to carry forward and use when markets rebound. Vanguard estimates that tax-loss harvesting can save investors 0.45% to 0.95% annually in after-tax returns, depending on volatility. However, as with most things, the devil is in the details.

Tax-loss harvesting involves selling and locking in portfolio losses to offset existing gains, future gains and a limited amount of ordinary income. Often, tax-loss harvesting is done only annually, with investors and money managers waiting until year end to sift through the losers and create some capital losses. Waiting, however, sets the stage for missed opportunities. Instead, use a more proactive approach and view tax-loss harvesting as a year-round activity. Stocks don’t wait until year end to offer the best opportunity to take losses.

In 2020, we witnessed the most recent example of a great tax-loss harvesting opportunity early in the year that dissipated towards year end when a sharp dip in markets in February and March was followed by a strong rally through 2020.

How It Works

When applying the tax-loss harvesting strategy, a losing investment is sold and is often repurchased so as to not have lost- opportunity costs in an investment. Once the losses are locked in, long- and short-term gains are offset in positions to neutralize or lower any tax impact. The “wash rule” prevents benefiting from a loss on positions repurchased 30 days after they are sold. There are, however, two workarounds. Under the current rule, investors can:

1) sell an exchange traded fund (ETF) and then buy an identical competing ETF and 2) sell a stock and buy a similar company or ETF that holds that stock. For example, an investor can sell Coke at a loss and buy Pepsi or an ETF that holds Coke, if there is an inclination that the consumer beverage industry is a great place to be.

Best Practices

Three are several basic premises to be aware of:

• Stocks ebb and flow throughout the year. To maximize the benefit of taxloss harvesting, investors and money managers need to actively look for low points and sell when they happen, not when loss harvesting is convenient. Obviously, every year brings a different experience for investors with differing low points, but the main objective here is looking for these dips throughout the year to maximize the tax losses.

• There are ways to enhance loss harvesting. Pooled vehicles, such as ETFs or mutual funds, benefit from a “sum of parts” approach, allowing tax-loss harvesting the losing parts of an index while holding onto the parts with gains.

• Mutual funds do have certain disadvantages. Because they tend to distribute capital gains near the end of year, without proper monitoring, these capital gains can blind side a well-intentioned tax strategy. The gains are based on the funds’ experience, not the investors. So even if a mutual fund was purchased toward the end of year, investors are responsible for the total year’s realized gains, even if they occurred prior to purchase.

It is important to note that too much tax-loss harvesting can start to look like churning (excessive trading of assets to generate commission). However, in a fee-only, non-commissioned advisory relationship, transacting creates no additional fees, only tax-loss harvesting benefits.

It clearly takes more time to tax-loss harvest throughout the year and can lead to more activity in portfolios, which can be jarring for some. It also requires a disciplined approach and an understanding of how to swap between investment types to take a tax advantage but not at the sake of missing out on future potential opportunities. Is it worth it? Absolutely. The research around its benefits is clear in concluding that this strategy adds value. With an active tax-loss harvesting strategy, investors can help take some of the bite out of year-end distributions with a smaller check to the IRS.

Robert J. Mascia, CFBS, is the founder and CEO of Green Ridge Wealth Planning. He can be reached at rmascia@grwealthplan.com