Whereas it’ll seemingly be laborious for buyers to reap the identical diploma of losses in both 2023 or 2024 as they managed in 2022 (and that’s a superb factor for portfolios), tax-loss harvesting has nonetheless been an vital consideration this yr, and specialists anticipate the identical for 2024.
The truth is, as Hiren B. Patel, head of advisor options at 55ip, lately instructed ThinkAdvisor, loss harvesting advantages from an “always-on mentality,” so advisors must be able to take potential motion early subsequent yr if the market situations are proper — each on the inventory and bond sides of the portfolio.
As Patel emphasised, the potential worth advisors can carry to their shoppers through efficient loss harvesting is difficult to overstate, particularly over the very long time horizon of the standard retirement investor. Whereas tutorial analysis suggests the typical annual “financial savings” or “extra return” is round 1% of a portfolio’s worth, that determine can vary as much as 250 to 300 foundation factors, relying on the methodology and the supervisor being thought of.
In greenback phrases, that equates to as a lot as $650 billion in tax financial savings that may very well be realized by advisors and their shoppers every yr, based on estimates supplied by Avantax. It’s a staggering sum of money that may very well be put again into the pockets of households throughout the U.S., Patel agreed, noting that advisors can now lean on corporations like 55ip to do a lot of the heavy lifting of tax administration on their behalf.
Whereas it does add one other layer of complexity to shopper service, Patel stated, the writing is now on the wall: advisors who ship superior after-tax efficiency will stand out from the competitors.
In that spirit, see the slideshow for a rundown of eight prime tax-loss harvesting suggestions for late 2023 and 2024.
1. Take into account harvesting losses on a near-monthly foundation.
In Patel’s expertise, many advisors and shoppers have a tendency to consider tax-loss harvesting as a market-driven or end-of-year occasion.
“What we’re doing as we speak is rather more proactive,” Patel defined. “We’re respecting the wash sale guidelines, after all, however we’re loss harvesting each 31 days, so it’s primarily occurring on a month-by-month foundation.”
Taking this method provides buyers alternative to seek out potential harvesting worth even when the markets are typically trending upward, as a result of there are inevitably going to be interim intervals of decline, both throughout the complete portfolio or particularly asset courses or sectors.
2. Bond portfolios profit from harvesting too.
One other widespread difficulty, in Patel’s expertise, is to see shoppers solely pondering and speaking about loss harvesting within the context of inventory market investments.
“The truth is that fastened earnings additionally presents a possibility for harvesting or banking losses, particularly when you’re in an rate of interest setting like this,” Patel stated. “For instance, earlier this yr, we harvested important losses within the first two quarters as charges continued to rise.”
The main target then swung as soon as once more within the third quarter again towards large-cap equities, Patel defined.
“As I stated, it takes an always-on mentality that scrutinizes all of the securities within the portfolio to ship the complete potential advantage of this sort of tax administration,” Patel stated.
3. Modest portfolio drift isn’t actually a foul factor.
As Patel recounted, one of many major advantages of direct indexing from a tax administration perspective is the power to vary — whether or not essentially or tactically — a shopper’s portfolio on the safety degree whereas replicating an underlying index.
By definition, nonetheless, any securities buying and selling to understand tax losses introduces variations in composition from the underlying index. Thus, there’s a potential for variations in threat and return, and due to this fact “monitoring error” is launched.
This “error” time period typically causes confusion amongst advisors and shoppers, however the actuality is that modest portfolio drift will not be a foul factor in most contexts.
The stability between managing portfolio variations from the index and the advantages of tax-loss harvesting could be always measured and successfully balanced, Patel stated.
4. ETF holdings and mannequin portfolios also can profit from loss harvesting.
As Patel explains, the identical common rules of loss harvesting inside individually managed accounts utilizing direct indexing additionally apply to the trouble to make the most of tax-loss harvesting in ETF and mutual fund mannequin portfolios.
Though tax-optimized mannequin portfolios have much less granular exposures for potential tax-loss harvesting, continuous and automatic analysis of each alternative and monitoring error has the identical potential to enhance after-tax investor outcomes.
5. Important dispersion exists even in a gentle market.
In keeping with Patel, the market’s conduct thus far in 2023 has proven clearly that important efficiency dispersion can (and normally does) exist even when broad market indexes are climbing steadily on a month-to-month or quarterly foundation.
This can be a principal cause why loss harvesting isn’t just helpful in painful years like 2022.
Patel factors out that, by Could of this yr, the S&P 500 was up 8%, whilst the vast majority of shares within the index have been down, with the median return for the yr at that time registering detrimental 0.2%.
In July alone, the S&P rose 3.1%, however the hole between one of the best and worst performers topped 55%.
“It’s the similar story on the sector degree,” Patel provides. 12 months to this point via July 31, the S&P was up greater than 20%. The know-how sector was up 46.6%, and communications companies jumped 45.7%, however utilities fell 3.4%.
6. Typically, endurance is vital when there are massive embedded positive factors.
Till lately, many advisors have had issues concerning the tax implications of transitioning their shoppers to a mannequin portfolio method, however that’s shortly altering due to new know-how and oversight methods that permit advisors to make the most of ongoing loss-harvesting as a method of offsetting the tax value of a giant portfolio transition with important embedded positive factors.
“I might say that is really there space the place we’re offering probably the most added worth to our partnering advisors as we speak,” Patel stated. “If the shopper is prepared to be slightly affected person and permit a transition course of to unfold over a time period, we will considerably scale back the general quantity of taxes they must pay.”
7. Strictly talking, tax alpha and tax financial savings aren’t the identical factor.
As Patel defined — and as he has written about intimately — it is not uncommon for informal observers to conflate the associated however distinct ideas of “tax financial savings” and “tax alpha.”
Merely put, tax financial savings is the distinction within the tax invoice a shopper realized for a portfolio that makes use of tax-loss harvesting versus one other with out tax-loss harvesting.
Tax alpha, however, is the distinction in funding efficiency between a shopper’s portfolio that makes use of a tax technique versus its benchmark.
8. Timing the market is an inferior method to loss harvesting.
Patel noticed that some advisors successfully attempt to “time the market” with their tax-loss harvesting actions, ready for giant drops earlier than they take motion.
Whereas that may be efficient to an extent, such advisors are seemingly lacking out on alternatives that will probably be recognized via the always-on method.
In 2021, for instance, the S&P 500 completed with important constructive returns, and a few advisors might by no means have pulled the loss-harvesting lever, Patel stated.
Nonetheless, almost 52% of the positions within the S&P 500 noticed a 15% or higher drawdown sooner or later within the yr — a giant missed alternative for individuals who weren’t watching carefully.
