With both stocks and bonds down significantly, you might not feel much like looking at account values. But if you turn away you could miss out on the chance to make the best of a bad situation. Today’s negative returns are an opportunity to harvest losses.
How does tax-loss harvesting work? In taxable accounts, when you sell a position that has lost value, you can use the loss to offset capital gains that result from selling securities at a profit during the year. Your booked losses can also offset funds’ annual capital gain distributions.
At year end, if your capital losses exceed your gains (or if you don’t have any gains), you can use the losses to offset up to $3,000 in non-investment income, even though that is often taxed at a higher rate than capital gains. Losses greater than $3,000 carry forward and can be used to offset capital gains and ordinary income over your lifetime.
Importantly, when reinvesting proceeds from the sale of a losing investment, you must abide by the Internal Revenue Service’s Wash-Sale Rule, which 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.
Why harvest losses now? Because losses are extensive. And if the market rebounds later this year, you could lose your chance.
Stock and Bond ETF Strategies See Large Losses
Analyzing ETF market performance by broad-based strategy profiles underscores how pervasive losses have been. More than 90% of all stock- and bond-focused ETFs have losses, covering $4.6 trillion assets from equity and $1.1 trillion for bonds, as shown in Figure 1. And almost 70% of equity funds have a more than 10% loss, totaling $3.9 trillion in assets.4 Given the negative returns of these two asset classes, it’s no surprise that mixed allocation funds have seen similar losses.
Commodity ETFs are the only category where the majority of funds have seen gains – with broad based commodities up 32% this year.5
Figure 1: Percent of ETFs by Fund Category With Losses Year to Date
Losses Recorded Across All Equity Categories
As shown in Figure 2, 96% of all funds focused on US equities (ex-sectors) are trading at a loss — and no category has fewer than 80% of funds in negative territory.
While US sector funds have the fewest number of funds trading at a loss (80%), their average loss is much greater than that of the broader US equity segment because of the more concentrated nature of sector strategies.
Across equities, emerging market (EM) and thematic ETFs have seen the worst drawdowns year to date. Thematic ETFs also have the worst average loss at -28.5%. The silver lining? Because so much investment in thematic funds took place in just the past two and a half years, this category is ripe for harvesting losses.
Figure 2: Losses by Equity Category
Bond ETF Losses Are Even More Widespread
100% of bond ETFs are trading at a loss in six of 11 fixed income segments. Though average bond ETF returns are not as poor as equity returns, in eight of 11 bond sectors returns are worse than -9%.
Bank loan funds, because of their exposure to floating-rate securities that have minimal duration risk, have fared the best amid rising rates — even though every fund is down on the year. Convertibles have the worst return of any bond sector tracked due to their equity sensitivity.
Figure 3: Losses by Bond Category
Longer-Term Losses Less Bleak, Still Significant
The above analysis of year-to-date results assumes every investor bought on December 31, 2021. But we know this is not the case. Of the 91% of funds trading at a loss, only 10% had inflows on the last day of 2021.6 So, is the picture less bleak for longer-term investors?
After normalizing the buying timeframe, our analysis reveals more than half of all ETFs are trading below their three-year average price [Figure 4]. These losses are on $2 trillion of assets, a big field of opportunity for harvesting.7
So while losses are somewhat less bleak when you take a longer term view, they’re still significant. In fact, 46% of all ETFs are trading below their average overall historical price dating back to their inception. This covers $662 billion in assets.8
Figure 4: Percent of Funds With Losses Based on Average Period Price
Shop for Tax Swaps and Know the Rules
Amid elevated cross-asset volatility, the losses continue to pile up — and not just among ETF strategies. Today, 96% of all mutual funds are trading at a loss, covering $15 trillion of assets.9
Painful to watch? Yes. No one likes to lose. Make you feel helpless? It could. But you don’t have to feel that way. There is something you can do. Because you may be looking at the largest tax-loss harvesting opportunity in decades.
In addition to potentially reducing your tax burden, harvesting losses offers you the chance to rotate into more cost-efficient strategies or better align exposures to current market trends. After selling a losing position, investors typically use a “tax swap” — a similar but not identical security — as a placeholder to maintain exposure to the asset class for 30 days. After 30 days, you can choose whether to switch back to the original holding.
Keep in mind that if the new investment appreciates and you sell it within a year, those gains will be taxed at the short-term capital gains tax rate, which is higher than the long-term rate. So, it may be advantageous to choose a swap that could become a long-term holding.
Why Harvest Losses Now
Again, if you harvest losses only at year end as many do, 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 realized gains. That’s why it is best to implement tax-loss harvesting throughout the year as losses occur.
And right now, you’d be hard-pressed to find a portfolio ledger or account value unaffected by equity and bond market losses. If you don’t look away, as tempting as that may be, you just might see the subtle shimmer of a silver lining in tax-loss harvesting.
1 Bloomberg Finance, L.P., as of May 23, 2022, based on the return of the Bloomberg US Aggregate Bond Index. 2 Bloomberg Finance, L.P., as of May 23, 2022, based on the holdings of the MSCI ACWI IMI Index. 3 Bloomberg Finance, L.P., as of May 24, 2022, per SPDR Americas Research calculations. 4 Bloomberg Finance, L.P., as of May 24, 2022, per SPDR Americas Research calculations. 5 Bloomberg Finance, L.P., as of May 23, 2022, based on the return of the Bloomberg Commodity Index. 6 Bloomberg Finance, L.P., as of May 24, 2022, per SPDR Americas Research calculations. 7 Bloomberg Finance, L.P., as of May 24, 2022, per SPDR Americas Research calculations. 8 Bloomberg Finance, L.P., as of May 24, 2022, per SPDR Americas Research calculations. 9 Morningstar, as of May 24, 2022, per SPDR Americas Research calculations.
Bloomberg Commodity Index Bloomberg Commodity Index (BCOM) is calculated on an excess return basis and reflects commodity futures price movements.
Bloomberg US Aggregate Bond Index The Bloomberg US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.
MSCI ACWI IMI Index The MSCI ACWI Investable Market Index (IMI) captures large, mid and small cap representation across 23 Developed Markets (DM) and 23 Emerging Markets (EM) countries.
The views expressed in this material are the views of the SPDR Research and Strategy team through the period ended May 24, 2022, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
Unless otherwise noted, all data and statistical information were obtained from Bloomberg Finance, L.P. and SSGA as of May 24, 2022. Data in tables have been rounded to whole numbers, except for percentages, which have been rounded to the nearest tenth of a percent.
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Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies.
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