From the experts: Tax Loss Harvesting

The 2022 calendar year is drawing to a close and it is a good time to review your balance sheet investments, specifically your taxable holdings. This year’s extreme stock market volatility may have caused you to refrain from checking your brokerage account balance, but it’s time to evaluate your positions. I say this in reference to a sophisticated investment strategy known as tax loss harvesting.

Essentially, this involves the sale of underwater shares 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, that sounds like a failure. However, this is far from the case.

When filing your taxes, realized losses can be used to offset realized losses capital gain. If there are excess losses after settlement, up to $3,000 may be considered as a Deduction against your normal income. Remaining losses can be carried forward for use in future years.

Any investor who cares about saving money needs to add this strategy to their arsenal. It’s a risk-neutral, no-brainer that reduces your tax burden. In addition, it can be implemented relatively easily.

Let’s illustrate the concept with a real example.

Real life example

Before the end of the year, I intend to take a tax loss absorbtion trade within my taxable portfolio, which consists of several low-cost stocks ETFs which give me highly diversified exposure to domestic equities, international developed market equities and international emerging market equities.

Trading relates to 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 deeply under water. This offers an opportunity.

My cost basis in SPEM is $88,000 and its current market value is $68,000. That leaves me with 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: pre-university education). By doing this, I will maintain my strategic asset allocation and create some economic value – a $20,000 tax deduction.

Assuming a 25% federal effective tax rate, this trade to recover tax losses will ultimately generate $5,000 in savings ($20,000 × 25% = $5,000).

Final Thoughts

This blog is for investors who manage their own investments. If you work with a financial advisor, he or she should conduct tax loss collection transactions on your behalf whenever the opportunity arises.

However, blind trust is not recommended. If you haven’t heard your advisor mention tax losses in the past, engage him or her in a conversation.

Any reputable fiduciary advisor will welcome the opportunity to outline the strategy, enlighten you on how it works, and provide a history of when such trades were made in your account. If your advisor isn’t transparent and eager to respond, you might want to reconsider the relationship.

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

Last edited: November 14, 2022

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