In Portland, the seasons have changed. Local breweries boasting seasonal beers are now offering dark porters in place of pumpkin ales. Ugly Halloween costumes have been replaced by ugly sweaters. And while the season typically associated with Harvest is behind us, there is another type of harvesting season that should be in full swing – Tax Loss Harvesting (TLH).
What is Tax Loss Harvesting?
The process of selling securities in taxable accounts for a capital loss (i.e. selling a mutual fund for less than you paid for it) which can be used to neutralize capital gains in the current year or offset capital gains in future years, thus “harvesting.”
If there are no capital gains to offset, up to $3,000 of capital losses in a given year can be used against ordinary income, and the rest can be used to offset capital gains in future years.
Please note, there are tax rules that investors need to be aware of—The Wash Sale Rule.
For example, let’s assume an investor has realized losses in a calendar year and ends the year with a net $20,000 loss. The first $3,000 of that loss will count against ordinary income, and the remaining $17,000 will be “harvested” for use in future years. In years where there are no capital gains, the $3,000 reduction of ordinary income will be taken. In years where the portfolio realizes capital gains, what’s remaining of the “Capital Loss Carry Forward” can be used to offset gains.
Turning Lemons into Lemonade
For stock investors, 2018 has not been kind. Per Tamarac’s AdvisorView, the following core asset classes of any diversified portfolio are down:
2018 YTD Performance:
- US Large Stocks (S&P 500) -5.91%
- US Small Stocks (Russell 2000) -12.31%
- International Stocks (MSCI EAFE) -15.48%
- Emerging Markets (MSCI Emerging) -16.10%
While not fun, lousy stock returns are nothing new. This, of course, is the reason for building diversified portfolios. Accepting you’ll never capture the returns of concentrated portfolios is a large hurdle to climb for many, but an important one, considering the type of risk, and potential loss, that comes with concentration. In theory and practice, maintaining a diversified portfolio means you will almost always own a loser in your portfolio over shorter-time periods, and that’s okay.
Years like this one present an excellent opportunity for Tax Loss Harvesting. Take advantage of this opportunity and be sure to turn lemons into lemonade.
A Long-Term Strategy
In years like 2018 when the stock market feels more foe (and a volatile foe at that) than friend, it’s easy to lose track of what’s important. At Cordant, we’re big proponents of accepting what the market gives us and focusing our actions on what matter.
Like many principles of financial planning, TLH is an ongoing exercise and should be part of any investor’s strategy. Because a lot of investing is dealing with elements out of our control, investors are better off focusing on things in our control:
- Risk (i.e. stocks vs bonds),
- Costs (i.e. expense ratios, turnover ratios, trading costs)
- Global diversification (i.e. US stocks vs. International stocks)
- Taxes (i.e. TLH, Asset Location, Roth Conversions)
If you think you might benefit from tax loss harvesting, get in touch.
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