Tax-loss harvesting is a complex process, and sometimes, may not be the best strategy for an investor’s individual situation. That’s why it’s especially important for advisors to understand exactly what the process is, how it works, and when it is appropriate or advisable to deploy for their clients.
Tax-loss harvesting is a strategy that liquidates losing or underperforming investments, uses those losses to offset gains in other parts of an investor’s portfolio, and then allows for the repositioning of capital to improve the strength of a portfolio going forward. In short, advisors can harvest capital losses to offset capital gains and the tax liability that those gains incur. Investors can then use those losses to reduce their taxable income by as much as $3,000 per year.
Effectively, you’re turning investing losses into tax breaks by lowering tax liability, while also trimming the fat from a portfolio. Tax-loss harvesting turns losses into savings, making an investment portfolio leaner and better-positioned to generate returns in the future.
The actual process of tax-loss harvesting can be fairly complex. But without getting too granular, it’s essentially three steps:
It’s important to respect just how complex and onerous the tax-loss harvesting process can be, particularly for advisors — sifting through your investments, one by one, to find potential losses can be laborious and time consuming. It is, however, an important tool that, when deployed appropriately, can keep a portfolio in the best position to generate returns in the future. In fact, depending on the state of the markets and an investor’s specific tax bracket, the process can add between 1% and 7% to a portfolio’s annual after-tax performance.
Tax-loss harvesting sounds like a win-win, but again, it’s complex, and may not be an advisable strategy for all investors. Here are some important tips and caveats to keep in mind:
Make sure the strategy makes sense for an individual’s situation. Tax-loss harvesting is not the right strategy for every investor. For example, it’s not relevant for qualified retirement accounts in which taxes are paid on contributions or withdrawals — not on capital gains in between.
Carry the harvest forward. Losses can be saved and carried to apply to future tax years if they aren’t used right away — remember, there’s a $3,000 limit. So, if an investor doesn’t want or need to use their losses immediately, they can use them to lower their tax liability down the road.
Beware of ‘wash sales.’ A wash sale is triggered if a security is sold for a loss and then repurchased within 30 days. In this case, the IRS will disallow the investor to declare the loss. So, if an investor wants to take advantage of a harvesting strategy but remain invested, they’d need to liquidate their positions and find a similar, albeit not “substantially identical” fund or security to reinvest in. That may require some homework.
The strategy differs for stocks and ETFs. Tax-loss harvesting with ETFs can often only be done in down markets, whereas the strategy can be used for individual securities no matter the market environment. That distinction means that investors and advisors have more latitude to take advantage when strategizing with individual securities.
Think about costs. While there may be transaction costs involved in selling and reinvesting, investors also face opportunity costs. For instance, it’s possible that you could liquidate a position only to see it rally, and miss out on those gains.
While many advisors dread end-of-year tax preparation processes for their clients, Vise can do some of the heavy lifting — at no additional cost.
Using artificial intelligence, Vise’s technology can identify individual securities in a portfolio that may best be utilized in a tax-loss harvesting strategy — and by focusing on individual securities, Vise gives advisors the ability to improve their client’s standing no matter the overall market conditions. Advisors can then choose if or how much they’d like to offset through harvesting, and even reinvest a client’s funds using a multi-factor security process to match a client’s goals.
Vise’s goal is to make the process safe, easy, and effective, so that advisors can work smarter, not harder. After all, clients want their advisors looking forward and planning their next moves, rather than looking backward and crunching old numbers.
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