Tax-loss harvesting is a popular theme among ETF investors this time of year.
The idea is that you can sell securities that have lost value in your portfolio this year to offset any taxes you might have incurred on capital gains from securities that performed well.
ETFs are tax-friendly vehicles that rarely report capital gains to begin with, but there are still opportunities to implement tax-loss harvesting within ETF portfolios.
Here, five ETF strategists share how they do it, and why.
Gary Stringer, president & chief investment officer, Stringer Asset Management; Memphis, Tennessee
The lack of volatility this year has left little room for tax-loss selling, unlike what we saw in 2016. Unless we see a market decline or correction before the end of the year, we are unlikely to see much tax-loss selling.
Still, while most of our business is “model delivery,” we take advantage of tax-loss harvesting where we can. We try to harvest losses throughout the year rather than wait until the last minute. Market volatility gives us opportunities to harvest losses as the year progresses.
For example, market volatility in January and February offered plenty of opportunities to harvest losses. We might sell a sector ETF that’s down and replace it with our next-best idea, or just hold a broad equity ETF through the wash-sale period.
Harvesting losses in this way gives us greater flexibility when managing our tactical allocations because we don’t have to worry as much about realizing short-term gains if the market already gave us the opportunity to harvest losses earlier in the year.
Having the additional freedom to move is an important advantage of harvesting losses throughout the year.
Scott Kubie, senior investment strategist, Carson Wealth Management; Omaha, Nebraska
Finding losses to harvest in 2017 is going to be tough. Every style box is up. and only two sectors—telecom and energy—are down this year. Still, ETF strategists should be aggressive harvesters of tax losses, because ETFs make tax-loss harvesting less risky than other vehicles. You can maintain the same exposure while realizing the benefits.
Harvesting losses in individual stocks often involves swapping one firm in an industry for another. A common example is to sell Coke and buy Pepsi. While managing the sector risk, there is always the possibility that something will change in the competitive environment, and one will prosper while the other falters.
ETFs offer the opportunity to swap between broadly diversified pools while still harvesting the losses. The key decision is whether the tax benefits are worth cost of trading.
Dave Haviland, managing partner & portfolio manager, Beaumont Capital Management; Needham, Massachusetts
Historically, in some of our strategies—such as the BCM Sector Rotation and BCM Income—we have done tax-loss harvesting, but in the other BCM systems, no. However, as a tactical manager, our three rules-based systems tend to realize the losses, especially short-term losses, as a matter of course.
Does it add to returns? For taxable accounts, yes, especially if you’re negating a short-term capital gain.
Tax-loss harvesting can be important, especially for high-income earners and residents of states like Massachusetts, where the short-term capital gains tax is 7% higher than the long-term rate. Obamacare adds another 4%. In a worst-case scenario, the total tax rate on short-term gains could be as high as 56%.
There’s not really a “proper” way to do tax-loss harvesting. At the strategist level, we have to be cognizant of tax-deferred accounts and the costs of trading into an alternative ETF. Therefore, unless the system wants to sell, we only harvest relatively large unrealized losses, and are quite judicious about it.