Why So Many Firms Do Tax Loss Harvesting Wrong
Why So Many Firms Do Tax Loss Harvesting Wrong
If you believe you're paying too much in taxes, don’t blame your CPA. Instead, take a look at your portfolio.
Chances are, your advisor or CFP overlooked one (or more) opportunities to reduce your tax burden through tax loss harvesting.
What is tax loss harvesting in a nutshell? Think about it as selling an investment at a loss so you can offset any current or future gains. Carried out at the right time, tax loss harvesting can give a welcomed boost to your long-term, after-tax returns, while simultaneously providing a wonderful opportunity to tune your portfolio depending on economic shifts.
That’s right, selling at a loss can actually save you money.
It might seem like a contradiction, especially if your portfolio is still young. But, rest assured, it’s a tried and true method. Our guide will explain how selling at a loss could be your best move.
Tax Loss Harvesting Basics
Your first move: don’t attempt tax loss harvesting yourself. It’s a full-time job that requires expertise, significant market knowledge and sophisticated softwares.
But the sad truth is: many who are charged with the task simply do not possess the tools nor talent to optimize tax loss harvesting.
Choosing the right advisor is paramount. You need an independent thinker with a track record of assisting clients through volatile markets with tax loss harvesting.
Expect the following:
- Your CFP or financial advisor frequently evaluates your portfolio, and tallies up any investments that aren’t earning their keep.
- After reviewing your portfolio’s performance, (including items incurring losses), you agree to sell some underperforming investments at a loss.
- Your advisor records this loss and uses it to reduce your taxable capital gains dividends.
- When market volatility presents opportunities, you and your advisor may discuss investing the money earned from the sale in new funds or securities. These will play well with your asset allocation strategy and overall investment plans.
Here are a few more facts about tax loss harvesting that provide a clearer picture.
Investment Eligibility for Tax Loss Harvesting
If you can’t bear to part with the investment you sold at a loss, you can just wait 31 days and repurchase the same stock. Buying it sooner is considered a “wash sale” by the IRS, which means you can’t take a tax deduction from the sale.
If tax loss harvesting is new to you, you may be wondering why your advisor never suggested it.
My Advisor Doesn’t Discuss Tax Loss Harvesting. Why Not?
Ideally, your financial advisor or Certified Financial Planner’s mantra should be: if there is a way to reduce your tax bill, do it.
But far too many investors never get the chance to save with tax loss harvesting. We think this is more than a little unfair, its patently irresponsible.
While it can appear complex, tax loss harvesting always follows the basic rules described above. And while the IRS regularly publishes guides with details of the newest capital gains tax brackets (in other words, those applicable to Schedule D), you don’t need to attend night school to keep up.
By now, you may be thinking “This could have saved me money during the last few years, especially after COVID hit. Why didn’t my financial planner tell me about this?”
Here are some possible reasons why.
Why Advisors Drop the Ball on Tax Loss Harvesting
There are several reasons why financial advisors overlook or shy away from tax loss harvesting.
Many Stick to a Traditional, Unchanging Approach
In other words, they develop basic portfolio management skills and stick with them, no matter what. These advisors could be described as having a “deficit of intent,” meaning as long as they’re collecting their fees and their clients’ portfolios perform marginally well, they’re happy.
Or, lack the sophistication and staff.
While these advisors may construct a well-diversified portfolio, they may not take their clients’ future tax liabilities into account.
Investing and taxes can be unwieldy topics. Partners are sought and trusted to place clients' minds at east - ensuring they're positioned as best as possible. Should a major tax liability be encountered, partners will likely begin scrambling for ways to minimize their clients’ tax bills. But if they’ve waited until the end of the year to begin, it’s simply too late to put a tax-loss harvesting strategy to work.
Is Your Advisor Guilty of These?
Other reasons why tax-loss harvesting isn’t part of an advisor’s services:
- They don’t review their clients’ portfolio performance regularly. If they did, they would introduce their clients to strategies for swapping out losing stocks or funds.
- They follow an over-simplified capital gains distribution timeline. While one can politely describe this as under-managed, others might point out the more obvious: these advisors are slacking.
- Even if an advisor understands the potential of tax-loss harvesting, they may not know how to create a portfolio that can take maximum advantage. A portfolio needs to be structured so clients not only sell at a loss; there should be several built-in opportunities to make up for the loss.
Advisors who are new to the business may have never guided their clients through an unexpected, unpredictable down market, a time when tax-loss harvesting can be particularly beneficial.
One Unexpected Pandemic, Two Tax-Loss Harvests, One Big Payoff
Here is an example of how RiversEdge advisors deployed effective tax-loss harvest strategies for a client when COVID-19 arrived in early 2020. These contributed to our client’s six-figure profit during an especially challenging year.
You’re Going to Like It Here.
During November 2019, a new client deposited a total of $200,000 into a portfolio, under the guidance of RiversEdge advisors.
Let’s Think Big.
A month later, the client decides to increase his portfolio worth, depositing over $6 million. RiversEdge responds to the client’s investment preferences by designing sleeved investment accounts with similar characteristics.
Storm Clouds Gather. Time to Harvest.
Weeks later, COVID-19 began to spread in China. Manufacturing facilities are put on lockdown and production in China stops. RiversEdge identifies an opportunity for tax-loss harvesting and initiates over $350,000 in sales for the client.
Time to Double Dip.
March arrives and COVID-19 continues to spread. A global pandemic is expected to be declared. On the day the pandemic becomes official, March 20th, RiversEdge and the client plan a second tax loss harvest.
It’s Not a Bear Market. It’s an Opportunity.
RiversEdge advisors meet with their client to discuss recovery strategies. The client prefers an aggressive approach.
A Fast-Track Portfolio Recovery
RiversEdge carries out a series of purchases during 2020 when prices are low. This enables the client to recover from the losses incurred during tax loss harvesting.
It Was a Bumpy Ride, But We Came Out Ahead. (And So Can You.)
Although 2020 was a rough ride for global markets and investors, our client came out way on top, with a six-figure increase to the total portfolio.
If you’re convinced that tax-loss harvesting is an ideal strategy for today’s volatile markets, congrats. But perhaps you would like an answer to this question:
You’re Saying It’s Impossible to Find an Advisor Who Can Prevent Losses?
Over the years, our advisors have been asked why they can’t manage a portfolio with zero losses. Here are several reasons why.
- A perfect portfolio doesn’t exist. Not every asset, fund and stock will rise in value at the same time. Instead, a skilled advisor will evaluate each portfolio on a monthly basis before advising clients of new possibilities and advantages.
- A properly-diversified portfolio will warrant tax-loss harvesting opportunities unto itself.
- Tax loss harvesting puts you in control of your taxes. Since you’re arranging to pay taxes at a future date, you’ll have time to ensure that you have the maximum funds in the market for the highest ongoing growth opportunities and compound interest.
Ready to do tax loss harvesting the right way…before the next tax bill arrives?