Executive Summary: With stock prices down and tax season here, now’s a good time to revisit tax-loss harvesting. It’s not a silver bullet, but if done right—especially if you reinvest the savings—it can help. I’ve laid out practical guidance and alternative funds for IVA Portfolio holdings to help you get started.
With the U.S. stock market nearly in bear market territory—the S&P 500 index is 17.6% below its February 19 high—even the most disciplined long-term investor may be itching to “do something.”
If you want to take action without upending your long-term plan, one tax-smart move to consider is harvesting any losses in your portfolio. I’ll be the first to tell you that tax-loss harvesting isn’t the slam dunk it is often held out to be, but if done correctly, it can be a worthwhile exercise.
Stock prices are down and tax season is here—perfect conditions to revisit tax-loss harvesting. It’s also a great starting point for a deeper dive into after-tax returns.
Farming Properly
Tax-loss harvesting involves selling a security at a loss and buying a similar holding in its place—so you might swap, say, Total Stock Market Index (VTSAX) for 500 Index (VFIAX). Those realized losses can be used to offset capital gains, which you’d otherwise owe taxes on.
In short, you get the tax benefits of booking a loss and get to stay invested in the market. It sounds like a win-win, right? Not so fast.
As I explained here, many investors mishandle tax-loss harvesting. The trick is to reinvest the tax savings—not just pocket them.
Tax-loss harvesting lets you save on taxes today but potentially hands you a larger bill in the future. Without investing today's tax savings, tax-loss harvesting is a wash; all you are doing is changing the timing of your tax bill.
The reinvestment of those tax savings powers the engine of tax-loss harvesting.
If you're thinking about harvesting losses, here are a few more things to keep in mind.
First, you must wait 30 days before swapping back to your original fund, or you’ll run afoul of the wash-sale rule. You can read more about this here, but the wash-sale rule is the IRS’s way of saying that if you realize a loss and the tax benefit that comes with it, you must give up any short-term benefits you might receive from owning the asset for some time.
Before switching back to your original fund, consider the tax consequences—one reason you must be comfortable with your alternate holding. I’ve seen investors who harvested losses in March 2009, near the bottom of the financial crisis, end up holding their replacement funds for years as markets rebounded.
Second, don’t go overboard with tax-loss harvesting. My rule of thumb: Only consider harvesting a loss of 10% or greater in a stock fund.
Finally, it may go without saying, but tax-loss harvesting only applies to taxable brokerage accounts. You can’t harvest losses in your retirement accounts.
How To Farm the IVA Portfolios
Whether you have losses to harvest comes down to your own portfolio—how long you’ve been in the market, when you bought your shares, that kind of thing.
Long-term holders of a stock fund like Dividend Growth (VDIGX) likely won’t have any losses to harvest. However, if you’ve entered the market more recently or added to your position, you could.
So, in the table below, I’ve provided one or two tax-loss alternatives for each IVA Portfolio holding.