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Charting the Market

Top Tax-Loss Harvesting Opportunities in Bonds and Sectors

There is nothing nostalgic about the tax-loss harvesting orchard this fall. With bonds suffering through another year of historic losses, the S&P 500 has posted double-digit gains. That means that, unlike most years, bonds and not equities are ripe for harvest.

But whatever losing position you sell in an effort to minimize taxes, a wide range of low-cost ETFs makes it easy to reinvest the proceeds to reduce your overall costs or better align portfolios with today’s market.

Head of SPDR Americas Research

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.

Core Bonds: Big Harvest Opportunities

With nearly $2 trillion in AUM, core bond ETFs and mutual funds have attracted over $180 billion in inflows this year.2 And more than 90% of those intermediate-core and Intermediate core-plus funds have posted negative returns.3

With bonds, the price return — which is the change from purchase price to sale price without coupons or dividends — is the measure that matters for harvesting. Because bond funds tend to distribute the bulk of their return in income distributions, their price return is usually well below their total return. Year to date:

  • The broad core Bloomberg US Aggregate Bond Index (Agg) is down -3.6% on a price return basis. On track to register its third consecutive annual decline — a record run of losses — the Agg’s total return year to date is -1.4%.4
  • The Agg is down -18% since the start of 2022 when the Fed began hiking rates aggressively.5
  • Core bonds’ three-year return is the worst ever. The rolling three-year return for the Agg is an annualized -5% and cumulative -15%.6 The Agg’s rolling three-year return has been negative since July 2022. So, anyone who has bought core bonds since the summer of 2019 is likely sitting on a loss.
  • Core bonds’ trailing one-year return, after removing the positive impacts from coupon payments, is -2%.7 Yet, due to base effects and higher coupons stemming from a higher rate regime, total returns have snapped back to +1.4%.8 But price returns, the figure that matters for tax-loss harvesting, are still negative.

Deeper Losses Across Bond Segments

Year to date, losses extend across traditional and non-traditional bond segments (Figure 2). For example:

  • Long Treasuries -12%9
  • Investment-grade 10-year Corporates -6%10
  • Mortgage-backed Securities -5%11
  • Municipal Bonds -4%12

Steeper Bond Losses Over Longer Time Horizons

Look at the price returns of the same assets listed above since the Federal Reserve began hiking rates at the start of 2022 (Figure 3). You’ll see there are more opportunities to harvest losses in these bond sectors mired in significant double-digit drawdowns:

  • Longer-duration Treasuries down -40%.13
  • High yield bonds -16%14 and -17% from their high water mark set in 2021.15
  • Preferreds -26% and Municipals -19%.16

Equity Losses in Emerging Markets, Sectors, and Style

Despite the strong headline double-digit returns of the S&P 500 Index, harvesting opportunities do exist (Figure 4):

  • Emerging-market equities are teetering between gains and losses. Losses are largely driven by the roughly -8% loss for Chinese stocks.17 (Thailand, -16%, and Chile, -10%, are also down18 but investors aren’t heavily allocated to those two markets).
  • Five sectors — Utilities, Consumer Staples, Real Estate, Health Care and Financials — are in the red this year. The highly rate-sensitive Utilities sector is leading the losses this year, almost 16%19 as macro forces severely negatively impacted the sectors return path.
  • Value stocks are down,-6.5% and Momentum -2.1%.20 This is mainly driven by the disperse return environment between value and growth.21

All but Energy Down Over the Longer Term

Plenty of major equity markets are still down a considerable amount from the start of 2022 (Figure 5). The Energy sector is the only equity market that has outsized returns since 2022,22 speaking to some of the power behind sector rotation strategies.

Resources to Help You Choose Tax Swaps

It’s worth repeating that the 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. That’s why investors use a tax swap as a placeholder to maintain exposure to the asset class for 30 days.

But, importantly, choosing a tax swap also can be a chance to reposition portfolios for the longer term. You choose a swap to:

  • Refine Portfolio Exposures. You could sell a passive fund and invest proceeds into an active strategy, potentially more suitable to navigate today’s complex macro risks. Or you could sell a broad-based sector fund and invest in a more specific sub-industry ETF.
  • Lower Portfolio Costs. Replacing higher-fee mutual funds with low-cost core equity and bond ETFs may help you build more cost-efficient portfolios while retaining asset class exposure. Note that the expense ratios for the SPDR® Portfolio ETFs are 95% lower than the median US-listed mutual fund.23

Check out our summary of asset classes with losses and SPDR® ETFs that can help you refine exposures or lower portfolio costs.

And our Morningstar Fund Comparison Tool can help you evaluate specific mutual funds and ETFs.

Keep in mind that if the swap 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 capital gains rate. So it may be advantageous to choose a swap that could become a longer-term holding.

As tax-loss harvesting season continues, look to our Market Trends pages for timely commentary, macroeconomic perspectives, and ETF flows data.