As the 2022 calendar year draws to a close, it’s a good time to review your investments, particularly your taxable holdings. This year’s extreme stock market volatility may have caused you to back away from checking your brokerage account balance, but it’s time to assess your positions. I say this with an eye toward a savvy investment strategy known as tax loss harvesting. 

Essentially, this entails selling underwater stocks or exchange-traded funds (ETFs) and immediately investing the proceeds in largely comparable securities. The strategic composition of your portfolio remains unchanged, but you realize capital losses on the disposed securities. 

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

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

Any investor that cares about saving money needs to incorporate this strategy into his or her arsenal. It’s a risk-neutral, no-brainer that will reduce your tax bill. What’s more, it can be implemented fairly easily. 

Let’s illustrate the concept with a real-life example.

Real-life Example

Prior to year-end, I intend to make a tax loss harvesting trade within my taxable portfolio, which consists of several low-cost ETFs that provide me highly diversified exposure to domestic stocks, developed markets international stocks and emerging markets international stocks.

The trade relates to my emerging markets ETF, State Street’s SPDR Portfolio Emerging Markets ETF (ticker: SPEM). I have great confidence in the long-run prospects of this sector, but it’s been beaten up badly 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 underwater. This presents an opportunity.

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

I’m going to sell all of it and immediately invest the proceeds in another underwater fund, Vanguard’s FTSE Emerging Markets Index Fund ETF (ticker: VWO). In doing so, I’ll 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 harvesting trade will generate $5,000 of savings ($20,000 × 25% = $5,000).

Closing Thoughts

This blog is directed to investors who manage their own investments. If you work with a financial advisor, he or she should be implementing tax loss harvesting trades on your behalf, whenever the opportunities arise.

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

Any reputable, fiduciary advisor will welcome the opportunity to outline the strategy, educate you on 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 eager manner, you may want to reconsider the relationship.

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: May 23, 2024