Tax Loss Harvesting

And a strategy to minimize its negative impacts while lowering your tax bill

Tax loss harvesting is the process of selling investments at a loss in order to offset capital gains. While the concept may seem simple, the strategy can be difficult to execute in practice.

There are a number of reasons why tax loss harvesting can be beneficial.

First, by offsetting capital gains with losses, taxpayers can reduce their overall tax liability.

Second, tax loss harvesting can help investors manage their portfolio risk. By selling losing investments, investors can reduce their exposure to potential future losses.

Third, tax loss harvesting can also be used to generate cash. When an investment is sold at a loss, the investor can use the proceeds to buy other investments. This can be especially helpful during periods of market volatility when it may be difficult to find investments that are both cheap and likely to appreciate in value.

Fourth, tax loss harvesting can create opportunities for “bargain hunting.” When an investment is sold at a loss, the investor can use the proceeds to buy other investments that are similar but have a lower risk of loss. This can be a way to improve the overall risk/return profile of a portfolio.

Tax loss harvesting is not without its risks. First, it can be difficult to time the market. Selling an investment too early can result in forgoing potential future gains. We start by assuming the investment will be purchased if the thesis is unchanged. Second, tax loss harvesting can lead to “chasing losses.” This occurs when investors sell winning investments in order to offset losses. This can lead to a cycle of selling winners and holding onto losers. Third, tax loss harvesting can create “tax drag.” This occurs when the gains from selling losing investments are offset by the taxes paid on the gains. One strategy to avoid some of these negative effects is to enter a broad market or sector specific ETF to maintain market exposure during the 30-day period, then, if appropriate, re-enter the position.

Despite these risks, tax loss harvesting can be a powerful tool for investors. By offsetting capital gains and managing portfolio risk, tax loss harvesting can help investors achieve their long-term financial goals.

Schedule a Meeting with Michael Collins, CFA

Add WinCap Financial on LinkedIn