As recent market performance has demonstrated, market declines can happen at any time of the year — making now a good time to consider tax-loss harvesting.
Tax-loss harvesting used to be simply too complex and challenging a task to take on regularly.
Today, however, technology has made it possible to continuously monitor and rebalance portfolios throughout the year, harvesting losses where present, while eliminating the need for investors to pore over complex spreadsheets.
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While there are tools available for individual investors, working with a professional can help maximize their efficiency, especially those with complex financial structures.
The Kiplinger Building Wealth program handpicks financial advisers and business owners from around the world to share retirement, estate planning and tax strategies to preserve and grow your wealth. These experts, who never pay for inclusion on the site, include professional wealth managers, fiduciary financial planners, CPAs and lawyers. Most of them have certifications including CFP®, ChFC®, IAR, AIF®, CDFA® and more, and their stellar records can be checked through the SEC or FINRA.
In its most basic form, tax-loss harvesting is when an investor sells assets that have fallen in value and uses those losses to offset gains from other assets. Those losses can be used in either the current or future calendar years.
Maintaining records is critical
It’s simple enough in concept. However, maintaining records for every tax lot (the record of the details of a given purchase of securities), including trade date, number of shares and average cost basis, can be overly complex and tedious for most individuals. But doing so is essential to conducting effective loss harvesting.
To illustrate the complexity of efficient tax-loss harvesting without tech help, consider a single portfolio consisting of 15 securities, each with 15 tax lots. Those 225 tax lots would need to be reviewed, most likely in a spreadsheet, prior to any rebalancing actions, assuming those actions were to be done tax efficiently.
Given that most investment managers typically oversee dozens or even hundreds of portfolios, continuously monitoring all portfolios for tax-loss opportunities would be almost impossible.
This is why tax-loss harvesting was rarely undertaken by anyone who didn’t employ a small army of dedicated, spreadsheet-wielding analysts. It’s also why many investors and advisers conducted tax-loss harvesting on an infrequent basis, often just once a year and typically in the fourth quarter.
Technology offers some help
However, technology has transformed the practice of tax-loss harvesting. New software tools allow investment managers to review portfolios on a daily basis without needing to manually sift through every individual tax lot.
Armed with better information, investment managers can now optimize the timing of tax-efficient portfolio actions.
The rise of new portfolio management technology has been accompanied by the proliferation of direct index strategies.
Direct index strategies provide investors with exposure to a specific index — for example, the S&P 500, the Russell 2000, etc.
However, unlike an index mutual fund or exchange-traded fund (ETF), where investors own shares of the fund, with a direct index, investors own the individual constituents of the index.
Doing so results in potentially hundreds of tax lots within a portfolio. With newer portfolio management systems, that becomes advantageous from a tax-efficiency standpoint.
In 2024, the Magnificent 7, or Mag 7 stocks — Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT), Amazon.com (AMZN), Meta Platforms (META), Tesla (TSLA) and Nvidia (NVDA) — accounted for over half of the S&P 500’s 23% return.
As a result of their strong performance, the Mag 7 accounted for roughly 35% of the entire S&P 500 at year-end. Among the other 493 stocks in the S&P 500, many underperformed or even experienced outright declines.
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With a direct index, investors can participate in the strong growth of the Mag 7, or any other stocks driving market performance.
At the same time, because they own the underlying stocks in the index, and not shares of a single fund, they can easily harvest the losses of underperforming companies to tax-efficiently rebalance their portfolios.
Mitigating risk and improving tax efficiency
Even in situations where one or more large concentrated holdings are throwing the balance of an investor’s portfolio out of alignment, investors are sometimes reluctant to sell because of the tax implications.
But tax-loss harvesting and the software tools to analyze it can make a sale more palatable in these cases.
Consistent and ongoing rebalancing across your portfolio can help mitigate risk and improve tax efficiency, while maintaining proper diversification.
By continually harvesting losses and using them to offset gains in other areas of the portfolio, an investor can lessen the tax liability that would undoubtedly build over time.
Active tax management is a change in the way portfolios have traditionally been managed. However, with improvements in technology, it is practical to do in portfolios of all sizes.
If you are not currently taking advantage of these new technologies, and their inherent benefits, it’s time.
This content is for informational purposes only and does not constitute legal or tax advice. Please consult your legal or tax advisor for specific guidance tailored to your situation. First Western Trust Bank cannot provide tax advice. Please consult your tax advisor for guidance on how the information contained within may apply to your specific situation.
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