IFA's Quote of the Week - 6 (Mark T. Hebner)


"For most investors, tax loss harvesting is one of the most important ways to reduce tax liability now and in the future."


- Mark T. Hebner, President of Index Funds Advisors & author of Index Funds: The 12-Step Program for Active Investors



As tax reporting documents trickle in and investors ponder their current tax situation, it’s a good opportunity to give you some insight into a powerful tax-savings tool called tax loss harvesting. In fact, the recent market downturn provides you with an opportunity to examine your specific situation to identify whether you can save on future capital gains taxes. 

To save on future taxes, investors might consider the following strategy:

  1. Take the mutual funds in your taxable accounts that have recently gone down more than about 10% and a minimum of about $10,000, due to the market correction
  2. Sell those funds and immediately invest them in the S&P 500 realizing a capital loss on the sold funds.
  3. Purchase the original mutual funds back after 31 days, to avoid the IRS Wash Sale Rule.
  4. Use the realized capital losses to offset future capital gains, reducing future tax bills. The losses can be carried forward until they are used up.

By transferring the money into the S&P 500, investors can remain 100% invested in the market.  Additionally, certain institutional custodians charge no transaction fees when we buy and sell their specified S&P 500 index fund.

This tax-loss harvesting process is a commonly used technique that will reduce future capital gain tax liabilities. 

While tax loss harvesting is a valuable tool, there are some risks associated with it. As such one should carefully consult with a financial advisor prior to making the decision to tax loss harvest. 

Examples of such risks include:

1) If you move into the S&P 500 and the market dramatically increases during the 31 day interval, all your realized losses will be taken up by realized gains when you sell the S&P 500 fund. For this reason we will only sell funds that have lost about 10%. It is extremely unlikely that the market increases 10% in one month. In fact, over the last 50 years, the S&P 500 index has increased 10% in one month only 1.7% of the time. 

2) The S&P 500 fund could incur a greater loss or a lesser gain than the funds you moved out of during the minimum 31 day interval. The likelihood of this is about 50% but the difference in value, if any, is likely to be small because of the short time interval. You should be aware of this risk before you pursue further any tax-loss harvesting.

Despite the risks mentioned, IFA frequently advises clients to harvest losses under the conditions described above. The painting below aptly depicts the reason why all tax-paying investors should understand and implement, if appropriate, a tax loss harvesting strategy. Of course, your decision to tax loss harvest should be carefully weighed and discussed with a qualified fee-only advisor who carries the fiduciary standard to act in your best interest. If you would like to take advantage of IFA’s expertise in tax-loss harvesting, or simply learn more about whether such action is appropriate for you, please call 888-643-3133 to speak with one of our many qualified investment adviser representatives.