As we approach the midpoint of the year, many investors and financial advisors are evaluating portfolio returns that look much less rosy than in recent years. Both stock and bond investors have faced challenging times. As of May 24th, almost every major market index across stocks and bonds had delivered substantially negative returns. A few are listed below for reference:
- Bloomberg US Aggregate (bonds): (8.9%)
- S&P 500 (US stocks): (16.8%)
- MSCI ACWI (global stocks): (16.6%)
- Nasdaq Composite (technology stocks): (27.8%)
While the markets have been a bit treacherous to navigate this year, we believe it is important for investors to keep a long-term outlook that aligns with their wealth management strategy. From a risk management perspective, we are of the opinion that making drastic changes due to changing market conditions is generally not advisable; however, there are some tax planning considerations, such as tax-loss harvesting, that investors should consider following these recent market declines.
What is Tax-Loss Harvesting?
At its core, tax-loss harvesting is an investment management strategy that involves the process of selling an asset at a loss to offset other capital gains in the portfolio. Often, an investor will purchase a similar (but not like-kind) security to replace the one they sold to keep exposure to a particular asset class. This allows the investor to capture the tax loss and maintain a similar exposure in the portfolio as they had prior to the sale.
It is typical for many investors to address tax concerns toward the end of the year. Conversations with accountants and financial advisors about capital gains usually begin during the holiday season, as last-minute adjustments can sometimes be made to reduce capital gains related tax liabilities prior to year-end. While implementing this strategy of reviewing accounts for losses before year-end is advisable, investors and their portfolio managers should consider reviewing accounts for losses on a more frequent basis, especially following periods of increased market volatility. Given the recent volatility in the markets, we put together a list of considerations when making tax-loss harvesting changes.
Tax-Loss Harvesting Considerations
Understand the wash-sale rule. This rule prohibits investors from selling an investment for a loss and purchasing the same or a “substantially identical” security for 30 days after the sale. If an investor does “buy back” that security during the 30-day window, the loss will be disallowed by the IRS.
Know the benefits and work with a trusted financial advisor. Capital gains/losses rules can become a bit complex, so we encourage clients to work with a financial planner or tax advisor to make sure everything is being properly tracked and accounted for.
- Capital losses are first used to offset other capital gains. There are also two types of capital gains/losses: short term (held less than one year) and long term (held over a year). Each type of loss is first netted against the related gain and then any net losses in one category can be used against net gains of the other kind.
- If an investor has excess net capital losses, they can use those losses to deduct up to $3,000 each year, according to IRS rules. The remaining losses can be carried forward to future tax years until the amount is exhausted. Work with your accountant or a tax consultant to ensure these carryover losses are tracked for future years.
- It’s important to remember that these rules are for federal tax purposes, as each state has specific capital gains rules.
Consider all assets. Stocks are generally considered more volatile and riskier than bonds, giving way to a greater likelihood for tax-loss harvesting opportunities of poorly performing positions. However, expectations of rising interest rates have greatly impacted the bond market in 2022. Recent purchases of bonds may present opportunities to harvest losses for the first time in years.
Dig into tax lots. Purchases of securities made at separate times often result in different cost basis for those shares or units of a security. It is important to do the dirty work of digging into specific tax lots with your wealth advisor to optimize your tax savings.
Develop an interim strategy and make sure the sales work with your investment plan. Work with your financial advisor to make sure the sales you are making fit within the long-term approach or any tactical changes you are making for financial planning purposes. If the sale is a short-term change made solely for tax purposes, make sure you have an appropriate replacement asset to maintain exposure to the market but not violate the wash-sale rule.
Continually evaluate opportunities to tax-loss harvest. Work with your investment manager over time, as this strategy is an important piece to a long-term tax-efficient investment plan. Your advisor may have access to more sophisticated trading tools or investment opportunities that actively look for tax-loss harvesting opportunities.
Dealing with Market Volatility
Volatile markets are difficult to manage. Behavioral finance tells us that portfolio losses trigger fear and uneasiness in investor sentiment, which can cause investors to make irrational and emotional decisions. At Columbia Pacific Wealth Management, we seek to avoid those types of decisions and instead focus on the long-term outlook. However, we recognize volatile markets may also create opportunities for investors, such as tax-loss harvesting. We encourage you to reach out to your financial advisor to see what changes you may be able to make to capture value in your investment portfolio today.
Important Disclosure Information:
Different types of investments involve varying degrees of risk, including the risk of loss of your entire investment. Past performance is not indicative of future results. All opinions expressed herein are current only as of the date hereof and CPWM and its employees can give no assurance that the performance of any specific investment recommendation or investment strategy discussed herein, whether directly or indirectly, will be profitable, or that it will be equal to any historical performance level discussed herein. The discussion or information contained herein is not intended to be, and should not be deemed as, personalized investment advice. The recommendations made may not be suitable for your specific individual situation and we encourage you to discuss with your financial professional before undertaking any investment strategy or recommendation contained herein. The discussions contained in this blog is current only as of the date hereof and may change due to a number of factors, including varying market conditions.