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No one likes to hear the word "loss" when discussing their investment portfolio. In fact, many advisors have expressed concerns that prospective clients stop listening as soon as they mention the words "tax loss."
How can you help prospective clients see the benefits of tax-losses? Keep your explanation simple by framing tax-loss harvesting as a discount from the IRS that can help offset the impact of capital gains taxes and reduce their out of pocket burden.
Consider an example that underscores the importance of systematic tax-loss harvesting throughout the year using two hypothetical stocks: ABC and XYZ, which are both similar in industry, outlook and liquidity. Neither stock pays a dividend, and because their primary difference is share price, they tend to move similarly over time.
Imagine a tax-aware investor who invests $10,000 at the start of the year to buy 100 shares of ABC stock. They notice at midyear that both ABC and XYZ have experienced comparable price drops. Upon selling the original positions in ABC, the investor captured a $3,000 tax loss and then immediately reinvested the proceeds in XYZ stock.
The investor's shares of XYZ rebounded at year end and are valued at $12,500—a 25% pretax return on their initial investment. They can now use the $3,000 tax loss from selling their ABC shares to offset gains elsewhere in their portfolio. Assuming the investor uses this loss to offset a long term capital gain taxed at 23.8% at the federal level, the client could save over $700 come tax time.
Systematic tax-loss harvesting helps investors take advantage of the systemic volatility that is inherent in investing, see investment returns compounding over time and delay tax payments until a later date.
Bottom line: When framed and used properly, systematic tax-loss harvesting can help clients maximize their after-tax returns.
"Systematic tax-loss harvesting helps investors take advantage of the systemic volatility that is inherent in investing, see investment returns compounding over time and delay tax payments until a later date."
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1. Tax-loss harvesting isn't beneficial in a retirement account because the losses generated in a tax-deferred account cannot be deducted.
Investment strategies that seek to enhance after-tax performance may be unable to fully realize strategic gains or harvest losses due to various factors. Market conditions may limit the ability to generate tax losses. Tax-loss harvesting involves the risks that the new investment could perform worse than the original investment and that transaction costs could offset the tax benefit. Also, a tax-managed strategy may cause a client portfolio to hold a security in order to achieve more favorable tax treatment or to sell a security in order to create tax losses. Prospective investors should consult with a tax or legal advisor before making any investment decision.
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