The market downturn has created unrealized losses in many portfolios. The one bright spot is that tax-loss harvesting — the practice of selling investments in taxable accounts that have lost value to offset capital gains — can help to reduce taxes.
The loss offsets capital gains that result from selling securities at a profit during the year, as well as mutual funds’ annual capital gain distributions.
If capital losses exceed gains at year-end (or if there are no gains), losses can offset up to $3,000 in noninvestment income, even though that is often taxed at a higher rate than capital gains are.
Losses greater than $3,000 carry forward to offset capital gains and ordinary income over your lifetime.
Swap or Refine Exposures
The Internal Revenue Service’s Wash-Sale Rule prohibits claiming a loss on the sale of an investment if the same or “substantially identical” investment is purchased either 30 days before or after the sale date.
A “tax swap” can serve as a placeholder to maintain exposure to the asset class for 30 days. After 30 days, investors can decide whether to switch back to the original holding.
You can also invest sale proceeds in a way that repositions your portfolio to:
Value-style funds have underperformed broad equities by a large margin this year. While timing factors can be difficult due to their cyclical nature, consider a multifactor approach that incorporates minimum volatility to potentially reduce downside risk while maintaining upside potential.1
While broad Real Estate has experienced headwinds due to the COVID-19 pandemic, the same cannot be said for homebuilders. New home sales jumped to their highest levels since 2006 on scarce inventory, while earnings sentiment appears bullish. With rates suppressed for now, this trend shows no sign of stopping soon.2
SPDR® Portfolio ETFs offer low-cost exposure to the S&P 500®, S&P MidCap 400®, S&P SmallCap 600®, and S&P Composite 1500®—as well as S&P 500® Growth, Value and Dividend styles. And SPDR Portfolio ETFs’ expense ratios are 93% lower than that of the median US-listed mutual fund.3
Harvest When Volatility Strikes
If you wait until year-end to harvest losses, investments that were down early in the year could bounce back into positive territory — resulting in missed opportunities to sell losers and book losses to offset gains.
2016 was a textbook case of “use-it-or-lose-it” harvesting. The S&P 500 experienced significant drops early in the year, falling to -10.51%, but at the end of the year, it rallied to +9.54%.4
Source: FactSet, December 31, 2015 to December 31, 2016.
Past performance is not a guarantee of future results. The index returns are unmanaged and do not reflect the deduction of any fees or expenses.
Deriving the maximum value from harvesting losses requires basing your decisions today on a long-term view of both the asset and your needs.
If a loss is less than $2,000, tax savings can be eroded by transaction and tracking costs.
The longer it is, the greater the potential for anything you save in taxes and then reinvest to grow.
If an asset will be left to heirs, there’s less of a need to measure the value of harvesting a current loss against the future taxes that would be due if the asset appreciates. Because heirs receive a step-up in basis, growth doesn’t turn into a future tax liability.
1 Morningstar, SPDR Americas Research, as of 10/05/2020.
2 Bloomberg Finance L.P., as of 10/05/2020.
3Morningstar, State Street Global Advisors, as of 3/31/2020. The median expense ratio of the 22 SPDR Portfolio ETFs compared to the median expense ratio of oldest share class US-listed mutual funds of similar Morningstar Categories, which includes active and passive funds. The median expense ratio of oldest share class passive US-listed mutual funds of similar Morningstar Categories is 0.21%. SPDR Portfolio ETFs are 71% lower than the average passive US-listed mutual fund.
4 Bloomberg Finance L.P., 12/31/2015 to 12/31/2016.
S&P 500® Index A popular benchmark for U.S. large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.
S&P 500® Growth Index A market-capitalization-weighted index developed by Standard and Poor's consisting of those stocks within the S&P 500 Index that exhibit strong growth characteristics.
S&P 500® Value Index A market-capitalization-weighted index developed by Standard and Poor's consisting of those stocks within the S&P 500 Index that exhibit strong “value” characteristics.
S&P 1500 Composite Index The S&P Composite 1500 Index combines three leading equity indices, the S&P 500 Index, the S&P MidCap 400 Index, and the S&P SmallCap 600 to cover about 90% of U.S. market capitalization. It is designed to be a benchmark of the U.S. equity market.
S&P MidCap 400 Index A benchmark that seeks to target the mid-cap portion of the US equities market. The index covers more than 7 percent of the U.S. equities market. Included in the index are companies with market cap in the range of $1 billion to $4.5 billion. This range is reviewed from time to time to ensure consistency with market conditions.
S&P SmallCap 600® Index A benchmark that seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.
State Street Global Advisors and its affiliates (“SSGA”) have not taken into consideration the circumstances of any particular investor in producing this material and are not making an investment recommendation or acting in fiduciary capacity in connection with the provision of the information contained herein.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.
Standard & Poor's®, S&P® and SPDR® are registered trademarks of Standard & Poor's Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation's financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index.
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