As a Principal Wealth Manager at Savvy Wealth, I've had the privilege of helping numerous clients navigate the complex world of investments and taxes. One of the most effective strategies I've employed to help maximize investment returns is tax loss harvesting. In this blog post, we'll explore the benefits and importance of tax loss harvesting for investors, while delving into the reasons why it should be a year-round activity.
What is Tax Loss Harvesting?
Tax loss harvesting is the practice of selling investments that have decreased in value to offset the capital gains generated from the sale of other investments. By doing so, investors can reduce their overall tax liability and potentially even improve their portfolio's after-tax performance.
Benefits of Tax Loss Harvesting
- Reducing tax liability: By offsetting capital gains with capital losses, investors can reduce the taxes they owe on their current year and future capital gains. If there are no capital gains to offset, up to $3,000 of capital losses each year can be used as a reduction to ordinary income on your tax return. Capital losses can be carried forward in future years until used up. This can be especially beneficial for those in higher tax brackets, with significant capital gains, business owners with substantial capital gains after selling a business, or investors with a large taxable account to reduce their tax liability.
- Portfolio rebalancing: Tax loss harvesting can serve as an opportunity to rebalance your portfolio. As you sell underperforming assets, you can reinvest the proceeds into better-performing investments or those more aligned with your current risk tolerance and financial goals.
- Improved portfolio performance: Studies have shown that tax loss harvesting can boost after-tax returns by as much as 1% annually. This can make a significant difference in long-term wealth accumulation
- Opportunity for tax rate arbitrage: If you can harvest losses in a year when you're in a higher tax bracket and later realize gains when you're in a lower tax bracket, you can benefit from tax rate arbitrage, further enhancing your overall returns.
Why Tax Loss Harvesting Should be a Year-Round Activity
Many investors wait until the end of the year to harvest their losses, but this approach can lead to missed opportunities. By keeping an eye on your portfolio throughout the year, you can take advantage of market volatility and identify tax loss harvesting opportunities as they arise.
Here are a few reasons why tax loss harvesting should be a continuous process:
- Markets are unpredictable: Markets can be volatile, and waiting until the end of the year to harvest losses may mean missing out on valuable opportunities during market downturns.
- Avoiding the year-end rush: Many investors scramble to harvest losses at the end of the year, which can lead to increased trading volume and potential price distortions. By practicing tax loss harvesting year-round, you could avoid this rush and potentially benefit from more favorable pricing.
- Better risk management: Regularly monitoring your portfolio for tax loss harvesting opportunities can help you manage risk more effectively. If you notice a significant decline in an asset's value, it might be an indicator of fundamental issues that warrant a closer look.
Tax loss harvesting is a powerful tool that can help investors maximize their after-tax returns and could enhance overall portfolio performance. By incorporating this strategy into your investment plan and practicing it year-round, you can unlock its full potential and likely reap the rewards of a more tax-efficient investment approach. If you're unsure about how to implement tax loss harvesting in your portfolio, consider seeking the advice of a financial professional, like a wealth manager or tax advisor, who can guide you through the process.