Many financial advisors say that tax-loss harvesting is a good way to manage taxes on your investments at the end of the year. Exchange-traded funds can help you accomplish that.
Tax-loss harvesting centers on the idea that you can sell securities that have lost value this year in your portfolio to offset any taxes you might have incurred on capital gains from securities that performed well.
There’s a lot of literature on tax-loss harvesting, but Fidelity has done a great job of compiling data on how this works, and what to watch for. The company even offers a tax-loss harvesting tool for its clients, so we will share some of its insights.
Works For All Investors
As the company put it, “Whatever type of investor you are, planning ahead and starting early to evaluate a tax-loss harvesting strategy can help you maximize the potential benefits.”
“The size of the potential benefit from tax-loss harvesting depends on your income level and the amount of your short- and long-term capital gains, minus any current losses that you may have already realized or any losses carried forward from other years,” Fidelity said.
Here are the key points to know:
- Sell losers, but don’t forget to keep your portfolio balanced
At the end of the day, keep sight of your investment goals. If selling a losing stock, bond or fund is a good way to offset capital gains on something else, don’t let a tax-loss harvesting strategy hurt your portfolio diversification.
Here’s where ETFs are particularly helpful. Say you were going to sell a losing security for tax purposes only—meaning, it’s a security you actually wanted to keep. If you proceeded to buy it again within 30 days of the sale, you would run into the IRS “wash sale” rule, which would void the tax benefits you were hoping to capture.