Can Tax-Loss Harvesting Improve Your Investing Returns?

On this episode of A Wiser Retirement™ Podcast, Casey Smith, and Brad Lyons, CFP®, discuss whether tax-loss harvesting can improve your investing returns. They talk about how this strategy can help investors use market value losses of securities to offset gains and remain invested with a diversified portfolio.

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Tax-Loss Harvesting and Investing

In this episode, we will not cover IRAs, 401K plans, or SEPs. The tax-loss harvesting strategy we discuss applies solely to money in a brokerage account. This usually occurs when someone owns a business, inherits money, or was able to save a lot throughout their life. 

In financial planning, we ensure that clients understand that liquidating debt is a really important step on the road to financial success. We counsel them to pay off their car, and mortgage in preparation for retirement. When that happens early enough, excess cash is created. This extra cash goes into what we call an opportunity fund. Inside opportunity funds, money is invested differently than in long-term growth funds. When nearing retirement, if this money hasn’t been used, you can use it during retirement to live off of it with meager tax consequences. Before that though, while in the period of setting money aside, we also invest it. Simultaneously, looking for opportunities to utilize the tax-loss harvesting strategy.

What is Tax-Loss Harvesting?

Tax-loss harvesting is an investment strategy to increase your overall net after-tax return on the investment portfolio. If over time an investor has accumulated a position in a single stock or two and they have significant gains, in order to diversify away from that, they may want to use what we call a tax-loss harvesting strategy. Another way to use the tax-loss harvesting strategy is just as an ongoing investment strategy to utilize losses in the account to offset gains in other areas of the account. Overall, it is designed to utilize a decline in market value of any one security to offset a gain in any other security in the account on your tax return.

In a diversified portfolio, in any given year the S&P 500 for example, may experience as many as 50% of securities having a decline in value. Consequently, there are always opportunities to harvest losses. This is an interesting strategy given the fact that it’s constantly in motion. It is done over a number of years and the length of time it might take for this to be done can also be projected. 

Direct Indexing

Direct indexing is a way to utilize the tax-loss harvesting strategy, because you’re investing directly in the securities that make up an underlying index, such as the S&P 500. Financially oriented softwares have made this possible over the past few years. They are able to invest an entire portfolio into the S&P 500 directly and then track those securities as movements, as they go up and down, and that way find losses. Then, immediately sell that, harvest the loss, take that money, and reposition it into a security alike, allowing the investment to remain in the same category.

Additionally, you can purchase direct funds, and they are able to perform some of these same strategies. Normally, these funds are available through private banks, for example, you can buy a tax-loss harvested S&P 500. Although, that’s probably off-limits to a lot of investors. However, this is something that wealth management firms, like ours have direct access to. Therefore, direct funds can help make the tax-loss harvesting strategy a little simpler, too. In contrast, it is often mostly offered to high-net-worth individuals or family office distribution areas, given the fact that these groups benefit the most from these strategies.

Is Tax-Loss Harvesting for You?

The tax-loss harvesting strategy is an investment strategy to increase one’s overall net after-tax return on the investment portfolio. Ultimately, this approach is designed to utilize a decline in market value of any one security to offset a gain in any other security in the account on your tax return. Investors can greatly benefit from this strategy if well-guided by someone who understands it thoroughly.

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TIMESTAMPS:

0:00 Intro

5:29 Tax-Loss Harvesting and Investing

7:49 What is tax-loss harvesting?

10:10 Direct indexing

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