From the Experts: Harvesting Tax Losses

From the Experts: Harvesting Tax Losses

As the 2022 calendar year draws to a close, it’s a good time to review your investments, including your taxable assets. This year’s extreme stock market volatility may have put you off checking your brokerage account balance, but it’s time to assess your positions. I say this keeping an eye on a savvy investing strategy known as tax loss harvesting.

It’s basically selling underwater stocks or exchange-traded funds (ETFs) and immediately invest the proceeds in broadly comparable securities. The strategic composition of your portfolio remains unchanged, but you realize capital losses on the securities sold.

On the surface, it looks like a failure. However, this is far from the case.

When filing your taxes, realized losses can be used to offset realized capital gains. If, after offsetting, excess losses exist, up to $3,000 may be applied as deduction against your regular income. Any remaining loss can be carried forward for application in future years.

Any investor who cares about saving money should incorporate this strategy into their arsenal. It’s a risk-free and hassle-free solution that will reduce your tax bill. Moreover, it can be implemented quite easily.

Let’s illustrate the concept with a concrete example.

Concrete example

Before the end of the year, I intend to perform a tax-loss harvesting trade in my taxable portfolio, which consists of several low-cost ETFs that provide me with broadly diversified exposure to domestic equities, international equities from developed markets and international equities from emerging markets.

The transaction involves my emerging markets ETF, State Street’s SPDR Portfolio Emerging Markets ETF (ticker: HOPE). I have great confidence in the long-term prospects of this sector, but it has been hit hard by the war in Ukraine, China’s zero COVID policy, and other geopolitical stressors.

As a result, my ETF and all comparable ETFs are deep under water. This presents an opportunity.

My cost base in SPEM is $88,000 and its current market value is $68,000. That leaves me sitting on an unrealized capital loss of $20,000.

I will sell everything and immediately invest the proceeds in another underwater fund, Vanguard’s FTSE Emerging Markets Index Fund ETF (ticker: VWO). By doing so, I will maintain my strategic asset allocation and create some economic value — a $20,000 tax deduction.

Ultimately, assuming an effective federal tax rate of 25%, this tax-loss harvest trade will generate $5,000 in savings ($20,000 × 25% = $5,000).

Final Thoughts

This blog is for investors who manage their own investments. If you are working with a financial advisor, he or she should implement tax loss harvesting operations on your behalf whenever opportunities arise.

That said, blind trust is not recommended. If you haven’t heard your advisor talk about tax loss before, strike up a conversation.

Any reputable fiduciary advisor will appreciate the opportunity to outline the strategy, explain to you how it works, and provide a history of when such trades have been made in your account. If your advisor doesn’t respond in a transparent and forthcoming manner, you may want to reconsider the relationship.

Please seek the advice of a qualified professional before making any financial decisions.

Last modification : November 14, 2022

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