By SJS Senior Advisor Andrew Schaetzke, CFP®.
2020 has been one of the most volatile years in the stock market’s history, largely driven by uncertainty surrounding the COVID-19 pandemic.[1] From February 12, 2020 through March 23, 2020, the global stock market (as measured by the FTSE Global All Cap Index) fell roughly 34%. Since the bottom on March 23, 2020, it has rallied upwards almost 68% through December 10, 2020. This has provided a year-to-date 2020 global stock market return of 14%.[2]
Source: Google Finance. See Important Disclosure Information for additional details.
In a perfect scenario, your investments would only go up and you would never experience a down market. Unfortunately, this is not how markets behave and not a scenario that many people have experienced, not even Warren Buffett. However, just like past market crashes, there is a lesson to be learned from this year.
We believe that most investors should buy-and-hold broadly diversified investments for the long-term, and, more importantly, stay invested through periods of extreme market volatility, which is not easy. Nonetheless, we believe that investors can use market volatility to their short-term and long-term advantage. For example, in order to decrease clients' potential taxes over the short-term, SJS used tax loss harvesting particularly during February and March by selling certain investments with significant losses in taxable accounts and buying similar investments. As a result, many taxable investors now have significant net realized losses for 2020. This means that they may owe little to no taxes this year, and be able to carry any additional losses forward for years to come.
Some taxable clients have recently asked us: what can we do with our harvested losses? Investors may have the following options:
Sell investments with unrealized gains that you no longer want
Particularly if you want to sell out of specific investments in your taxable accounts in order to increase diversification and / or buy other investments, you can use your harvested losses in order to decrease your short-term expected taxes.
It is important to emphasize that you can use long-term harvested losses to first offset long-term capital gains, and then short-term capital gains. Similarly, you can use short-term harvested losses to first offset short-term capital gains, and then long-term capital gains.[3]
Rebalance your existing investments
If some of your investments in your portfolio have significantly outperformed, you can use your harvested losses to sell a portion of the outperforming investments.
We generally believe that over the long-term, deferring the sales of your highest-capital gains tax lots will potentially increase your long-term expected returns. Therefore, we generally advise clients to sell their lowest capital gains tax lots when rebalancing.
Decrease your federal taxable income by up to $3,000 for the year
If you have net losses from your taxable portfolio, you may be able to decrease your federal taxable income by $3,000 (or $1,500 if married filing separately). You can use this $3,000 annual net capital loss deduction regardless of whether you itemize or use the standard deduction when filing taxes. Additionally, some states allow you to decrease state income taxes using net harvested losses.[3]
Carry forward net realized losses for future years
While filing taxes, you can carry forward your unused net realized losses in order to do any of the above in future years. You do not have to use all of your net realized losses, and net realized losses typically do not expire.[3]
We think the above details productive uses for your harvested losses. However, there are some actions we generally advise clients to avoid. For example, we typically advise clients:
Do not realize capital gains just in order to use your net realized losses
Since you can carryforward net realized losses to future years, you do not need to use all of your harvested losses.
Do not take more investment risk in order to try to make up for realized losses
Sometimes, investors think that they should take additional investment risk in order to make up for losses earlier in the year. We often strategically realize losses for our taxable clients, and thus realized losses are not necessarily indicative of poor investment performance for the year. Therefore, we believe that investors should stick with their long-term investment plan instead of trying to make up for perceived poor investment performance.
Do not buy a substantially identical investment within 30 days of realizing a loss (Wash Sale Rule)
Because of the Wash Sale Rule, investors who realize a loss by selling an investment and then buy a substantially identical investment within 30 days cannot deduct the realized loss for tax purposes.[4]
Overall, we believe that using your harvested losses strategically as part of your tax loss harvesting process can increase your portfolio’s expected return over the short-term and long-term.
We spend our days helping clients figure out and improve their investments. If you have any questions on what to do with your harvested losses, or want to create a better tax loss harvesting process going forward, we would be happy to help you as well.
Important Disclosure Information And Sources:
[1] “The Craziest Month in Stock Market History.” Nick Maggiulli, 01-Apr-2020, ofdollarsanddata.com.
[2] The FTSE Global All Cap Index is a market-capitalisation weighted index representing the performance of the large, mid and small cap stocks globally. The index aggregate of around 8,000 stocks cover Developed and Emerging Markets.
[3] “Topic No. 409 Capital Gains and Losses.“ IRS, irs.gov.
[4] “Wash Sales.“ U.S Securities and Exchange Commission, investor.gov.
Advisory services are provided by SJS Investment Services, a registered investment advisor with the SEC. Registration does not imply a certain level of skill or training. SJS Investment Services does not provide tax advice. Please consult your tax professional for specific advice. This material has been prepared for informational purposes only.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
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