In grade school oxymoron was one of those words that could make you giggle after someone uttered it.  If I heard any word with “moron” in it, it sent me chuckling, so maybe that was just me.

Funny though, I find that often enough individuals focus too intensely on “part” of something and miss considering the “whole” meaning.  In a lot of cases, the more powerful overall meaning is what needs the intense focus.  So before we let our human filters get in the way, let’s take an undercover peek at an age-old trick that has been used by the investing elite for years.

Each year, thousands of investors take losers in their portfolio (valued at less than purchase price) and sell them to generate losses–on purpose!  This practice of “tax-loss harvesting” (or tax loss selling) can add extra juice to your investment portfolio.  Also, it is not as insane as you think as it can set in motion a few important benefits:

First, it frees up capital in your portfolio that can be used to rebalance it.  Too often we let our winners ride so long that it creates portfolio imbalance.  Psychologically, everyone likes to look at the asset that is up 200% while ignoring the one that is down 50%.  However, once you sell that loser in your portfolio, simultaneously you generate cash that can then been used to rebalance across all your asset classes.  So let’s say you have a really good year in bonds but your emerging equities have done poorly, sell some of each asset class and get back in balance and offset some of the tax liability–(see my next point!)

Secondly, it locks in losses that can be used to offset either long term or short term gains (or both!).   The combination of selling parts of your portfolio that are at a loss along with your winners can essentially create a neutralizing effect which lowers your tax liability.  With short term gains taxed at 20% for the highest earners (at the time of this writing) it makes sense to offset some of those gains since you are only keeping 80 cents of every dollar you make in gains.

Lastly, it presents an opportunity to buy assets on the cheap.  One other aspect of this strategy is that assets are generally on sale during this time of the year which can start as early as mid-October and run through year-end.   Why?  Because institutional asset managers are human too and they usually engage in “window-dressing” or “tax incentive selling” by selling losers and buying momentum assets prior to posting year-end performance numbers.  This is an opportunity to buy assets that are usually depressed due to momentum selling.

So now you have a general idea of what tax loss harvesting is.  Here are some suggested next steps to take advantage of any opportunities in your taxable investment portfolio:

  1. Grab last year’s tax return and look at line 13 from your 1040.  This number needs to be reviewed along with your schedule D.  Why?  Because any positive number adds to line 22 on your return and increases your tax liability.  Thus, it makes sense to find ways to lower it!
  2. Grab your last brokerage account statement for your taxable account(s).  Compare you current percentage in each asset class versus the target percentage.  If you don’t know this answer, set an appointment with your financial advisor to rebalance your portfolio!  If you are out of balance in any asset class these are prime candidates for harvests.  Consult with you financial advisor about what to sell and when to sell.  Hint:  Typically speaking you want to start the process before everyone else does.
  3. Learn more and ask a lot of questions.  This is not rocket science, but you will be a better steward over your wealth by understanding the value of strategies like this.  Consult with a financial advisor that will act as a guide providing sound, objective advice.

Going Further: