“Loss Harvesting” makes lemonade out of lemons
While stock market corrections can cause great amounts of anxiety for investors, they have always proven to be temporary setbacks in the stock market’s long-term appreciation. The goal-focused, long-term investor’s best response during a market downturn is to stay the course and allow the market to resume its upward march. Market corrections, however, do present opportunities for proactive investors to deploy investment management strategies that can reduce the sting of seeing investment values drop. One specific investment tool that Quantum employs is known as “loss harvesting”.
Loss harvesting is the process of strategically realizing investment losses in a taxable account. In order to harvest a loss, an investor sells a security whose current price is significantly less than the price at which he or she bought the security. The difference between the selling price and the purchase price is the realized loss for tax purposes. The key differentiator between loss harvesting and market timing is that a loss harvester will simultaneously buy a similar investment to maintain continuous market exposure. Loss harvesters are not running away from the market, but rather, they are taking advantage of what they know to be a temporary decline in asset prices!
The benefits of harvesting losses
Realized losses provide much needed flexibility in a financial plan. Realized losses from one asset (such as a mutual fund) reduce realized capital gains from other assets (such as another mutual fund or even real estate) and therefore reduce an investor’s tax liability. This can be useful for reducing the tax liability of other portfolio management functions such as rebalancing and generating cash. If an investor is looking to reduce exposure to a highly appreciated asset, he or she can use realized losses to reduce the associated tax liability. If realized losses are greater than realized gains in a given tax year, the realized losses can reduce ordinary income by up to $3,000 per year, and unused realized losses can be carried forward to future years.
Pitfalls
There are costs incurred when implementing a loss harvesting strategy. A tax rule known as the wash-sale rule prohibits the purchase of a security that was sold for a loss within a thirty day window. So an investor who has loss harvested a security must buy a different security to remain invested in the market. Then when the wash-sale window has passed, another two trades must be executed to sell the replacement security and re-buy the original security. The cost for executing these trades will vary by custodian and security type.
It is important to have a suitable proxy investment to hold while waiting for the wash sale period to end in order to maintain exposure to all the asset classes prescribed in an investment plan. If an investor does not buy a security similar to the one that is sold for loss harvesting, the investor runs the risk of missing out on any returns of that security because the replacement security may underperform the original.
Quantum takes all of these factors into account when looking for opportunities for loss harvesting. There is no action required on your part, but if you have any questions on the strategy, your Quantum advisor would be happy to go over it with you.
DISCLOSURE: Quantum Financial Advisors, LLC is an SEC registered investment adviser. SEC registration does not constitute an endorsement of Quantum Financial Advisors, LLC by the SEC nor does it indicate that Quantum Financial Advisors, LLC has attained a particular level of skill or ability. This material prepared by Quantum Financial Advisors, LLC is for informational purposes only and is accurate as of the date it was prepared. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Advisory services are only offered to clients or prospective clients where Quantum Financial Advisors, LLC and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Quantum Financial Advisors, LLC unless a client service agreement is in place. This material is not intended to serve as personalized tax, legal, and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Quantum Financial Advisors, LLC is not an accounting or legal firm. Please consult with your tax and/or legal professional regarding your specific tax and/or legal situation when determining if any of the mentioned strategies are right for you.
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