8 Tax-Loss Harvesting Tips for 2024
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While it will likely be hard for investors to harvest the same degree of losses in either 2023 or 2024 as they managed in 2022 (and that’s a good thing for portfolios), tax-loss harvesting has nonetheless been an important consideration this year, and experts anticipate the same for 2024.
In fact, as Hiren B. Patel, head of advisor solutions at 55ip, recently told ThinkAdvisor, loss harvesting benefits from an “always-on mentality,” so advisors should be ready to take potential action early next year if the market conditions are right — both on the stock and bond sides of the portfolio.
As Patel emphasized, the potential value advisors can bring to their clients via effective loss harvesting is hard to overstate, especially over the long time horizon of the typical retirement investor. While academic research suggests the average annual “savings” or “excess return” is around 1% of a portfolio’s value, that figure can range up to 250 to 300 basis points, depending on the methodology and the manager being considered.
In dollar terms, that equates to as much as $650 billion in tax savings that could be realized by advisors and their clients each and every year, according to estimates provided by Avantax. It is a staggering amount of money that could be put back into the pockets of households across the U.S., Patel agreed, noting that advisors can now lean on firms like 55ip to do much of the heavy lifting of tax management on their behalf.
While it does add another layer of complexity to client service, Patel said, the writing is now on the wall: advisors who deliver superior after-tax performance will stand out from the competition.
In that spirit, see the slideshow for a rundown of eight top tax-loss harvesting tips for late 2023 and 2024.
1. Consider harvesting losses on a near-monthly basis.
In Patel’s experience, many advisors and clients tend to think of tax-loss harvesting as a market-driven or end-of-year event.
“What we are doing today is much more proactive,” Patel explained. “We are respecting the wash sale rules, of course, but we are loss harvesting every 31 days, so it’s essentially happening on a month-by-month basis.”
Taking this approach gives investors opportunity to find potential harvesting value even when the markets are generally trending upward, because there are inevitably going to be interim periods of decline, either across the full portfolio or in particular asset classes or sectors.
2. Bond portfolios benefit from harvesting too.
Another common issue, in Patel’s experience, is to see clients only thinking and talking about loss harvesting in the context of stock market investments.
“The reality is that fixed income also presents an opportunity for harvesting or banking losses, especially when you are in an interest rate environment like this,” Patel said. “For example, earlier this year, we harvested significant losses in the first two quarters as rates continued to rise.”
The focus then swung once again in the third quarter back toward large-cap equities, Patel explained.
“As I said, it takes an always-on mentality that scrutinizes all the securities in the portfolio to deliver the full potential benefit of this type of tax management,” Patel said.
3. Modest portfolio drift isn’t really a bad thing.
As Patel recounted, one of the primary benefits of direct indexing from a tax management perspective is the ability to change — whether fundamentally or tactically — a client’s portfolio at the security level while replicating an underlying index.
By definition, however, any securities trading to realize tax losses introduces differences in composition from the underlying index. Thus, there is a potential for differences in risk and return, and therefore “tracking error” is introduced.
This “error” term often causes confusion among advisors and clients, but the reality is that modest portfolio drift is not a bad thing in most contexts.
The balance between managing portfolio differences from the index and the benefits of tax-loss harvesting can be constantly measured and effectively balanced, Patel said.
4. ETF holdings and model portfolios can also benefit from loss harvesting.
As Patel explains, the same general principles of loss harvesting within separately managed accounts using direct indexing also apply to the effort to utilize tax-loss harvesting in ETF and mutual fund model portfolios.
Although tax-optimized model portfolios have less granular exposures for potential tax-loss harvesting, continual and automated evaluation of both opportunity and tracking error has the same potential to improve after-tax investor outcomes.
5. Significant dispersion exists even in a steady market.
According to Patel, the market’s behavior so far in 2023 has shown clearly that significant performance dispersion can (and usually does) exist even when broad market indexes are climbing steadily on a monthly or quarterly basis.
This is a principal reason why loss harvesting is not just useful in painful years like 2022.
Patel points out that, by May of this year, the S&P 500 was up 8%, even as the majority of stocks in the index were down, with the median return for the year at that point registering negative 0.2%.
In July alone, the S&P rose 3.1%, but the gap between the best and worst performers topped 55%.
“It is the same story at the sector level,” Patel adds. Year to date through July 31, the S&P was up more than 20%. The technology sector was up 46.6%, and communications services jumped 45.7%, but utilities fell 3.4%.
6. Sometimes, patience is key when there are big embedded gains.
Until recently, many advisors have had concerns about the tax implications of transitioning their clients to a model portfolio approach, but that is quickly changing thanks to new technology and oversight techniques that allow advisors to utilize ongoing loss-harvesting as a means of offsetting the tax cost of a big portfolio transition with significant embedded gains.
“I would say this is actually there area where we are providing the most added value to our partnering advisors today,” Patel said. “If the client is willing to be a little patient and allow a transition process to unfold over a period of time, we can substantially reduce the overall amount of taxes they will have to pay.”
7. Strictly speaking, tax alpha and tax savings aren’t the same thing.
As Patel explained — and as he has written about in detail — it is common for casual observers to conflate the related but distinct concepts of “tax savings” and “tax alpha.”
Simply put, tax savings is the difference in the tax bill a client realized for a portfolio that utilizes tax-loss harvesting versus another without tax-loss harvesting.
Tax alpha, on the other hand, is the difference in investment performance between a client’s portfolio that utilizes a tax strategy versus its benchmark.
8. Timing the market is an inferior approach to loss harvesting.
Patel observed that some advisors effectively try to “time the market” with their tax-loss harvesting activities, waiting for big drops before they take action.
While that can be effective to an extent, such advisors are likely missing out on opportunities that will be identified through the always-on approach.
In 2021, for example, the S&P 500 finished with significant positive returns, and some advisors may never have pulled the loss-harvesting lever, Patel said.
However, nearly 52% of the positions in the S&P 500 saw a 15% or greater drawdown at some point in the year — a big missed opportunity for those who weren’t watching closely.
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