LUTZ BUSINESS INSIGHTS
Volatile Markets Can Lead to a Potential Harvest
NICK HALL, INVESTMENT ADVISER
PUBLISHED: DECEMBER 8, 2015
Global equity markets have seen their fair share of volatility in 2015, and the media does more than enough to remind you of this fact. With the problems in China, the Fed’s decision on the impending rate increase, and global oil prices falling dramatically you would think the markets are down substantially this year. Despite this intra-year volatility and all of the “noise”, US equity markets are virtually flat (S&P 500 Index up 1.28% and the Russell 2000 Index down 0.08%) as of market close at the end of November. International and Emerging Market equity sectors have also seen dramatic swings throughout the year, but surprisingly enough, some international sectors are also positive for the year. One of the silver linings of this volatility is the potential for investors to sell securities at a loss to offset capital gains or ordinary income during the year in a strategy known as “tax loss harvesting”.
Anytime you sell a security at a loss, you can offset potential long-term or short-term capital gains during the year. If there are no capital gains generated or the capital losses exceed capital gains, the net loss can be used to offset up to $3,000 in ordinary income. This is a major benefit to investors whose ordinary income tax rates far exceed lower capital gains rates (0%-23.8%). Additionally, if an annual loss is greater than $3,000, you can carry over these losses to offset gains and ordinary income in future years. Losses which are carried forward don’t expire until death.
One important note to keep in mind about harvesting losses is what to do after selling a security or securities to generate the loss. The IRS has a “Wash Sale” rule that prohibits a person from claiming a loss on the sale of an investment(s) if he or she buys the same or substantially identical investment within 30 days. Rather than sitting on cash for 30 days after the sale, you can invest in a very similar investment that is not substantially identical to the investment you sold but still gives you exposure to the same asset class in what is known as a tax swap. Once the 30 days have passed, you may choose to switch back to your original holding or stay invested in the swapped security. At Lutz Financial, we have identified securities we could use in each asset class as a preferred tax swap option to take advantage of any harvesting opportunities.
Harvesting can be a year-in-and-year-out activity depending on the portfolio. Dollar cost averaging into investment accounts or investing periodically will allow different entry points and tax lots into securities. In turn, you can cherry pick identifiable tax lots that have losses for a potential tax swap. Having a broadly diversified equity portfolio with many different asset classes which move in different directions at different times affords you the ability to cherry pick those asset classes which haven’t performed as well. For example, the emerging market asset class has been one of the worst performing asset classes during 2014 and 2015. The MSCI Emerging Markets Index year-to-date return was -15.48% as of September 30, 2015. This asset class would be low hanging fruit and be a logical place to book losses if there are any in a portfolio.
Volatility in the equity markets is normal, with an average annual intra-year decline of the S&P 500 of 14.2% over the last 35 years (http://blog.spdrs.com/post/tax-loss-harvesting-what-to-know). Harvesting losses is typically thought of as a year-end activity; although there are often many times throughout a given year to book an investment loss before waiting until year end.
Tax loss harvesting is a part of a long-term investment strategy that should focus on keeping an investor’s need in mind while also not being a detriment to the overall goals of the portfolio. When losses are harvested they aren’t eliminated; rather, they are deferred to some point in the future when the assets are liquidated. However, by saving on taxes now, you have the ability to invest tax savings. For example, assume $3,000 in losses was generated to offset $3,000 of ordinary income for a married couple in a combined 30% marginal tax bracket. This couple would have an extra $900 ($3000 x 30%) in their pocket in the form of tax savings. While this may seem insignificant, assuming this couple did this every year for 20 years and averaged an annual return of 8% on the reinvestment of the tax savings, this money would grow to $41,185 after 20 years. The longer the time horizon for investing or needing the funds, the greater the potential benefit the time value of money has on the value of harvesting losses.
Harvesting losses may make sense for people who are selling a business, looking to offset income, or those who are in a higher bracket now and anticipate lower income in the future. In an ideal world every asset class would have positive returns each year. However, history has shown volatility in equity markets is commonplace and may present investors with an opportunity to harvest losses when an investment or certain asset class is down. As with any investment advice, we would encourage you to consult a professional financial advisor or accountant to assess your particular situation with regard to harvesting losses or executing any trades that will have an impact on your tax situation.
We are always available to discuss tax loss harvesting with you and answers any questions you may have regarding the topic.
Important Disclosure Information
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.
ABOUT THE AUTHOR
NICK HALL, CFP® + INVESTMENT ADVISER
Nick Hall is an Investment Adviser at Lutz Financial. With 10+ years of relevant experience, he specializes in creating thorough, adaptive financial plans and investment management strategies for high net-worth families. He lives in Omaha, NE, with his wife Kiley, and daughter Amelia.
AREAS OF FOCUS
- Comprehensive Financial Planning
- Investment Advisory Services
- Retirement Planning
- Income Tax Planning
- Social Security and Medicare Planning
- Investment Project Research
- High Net Worth Families
AFFILIATIONS AND CREDENTIALS
- Financial Planning Association, Member
- CERTIFIED FINANCIAL PLANNER™
- BSBA in Finance and Business Management, Eller College of Management - University of Arizona, Tuscon, AZ
- Mount Michael Benedictine, Alumni Board President
- Lutz Gives Back, Committee member
- United Way, Volunteer
- Salvation Army, Volunteer
- Omaha Home For Boys, Volunteer
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- New Tax Legislation and Individual Financial Planning Strategies
- The Ins and Outs of Health Savings Accounts (HSAs)
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- Does a Roth IRA Conversion Make Sense for You?
- Clinton vs Trump: An Impartial Look Into the Tax Plans of Each Candidate
- Tax Deferral: A Very Powerful Financial Planning Tool
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