In the world of investments, we tend to only hear about the big wins…which is understandable. We, as investors, are conditioned to seek out the largest opportunity for gain, while simultaneously remaining cautious of the inherent risks in that opportunity. What if, only for 3 minutes while you read this article, we reverse our conditioning and seek out the opportunity in “losing.”

The investment strategy commonly referred to as “tax loss harvesting” has been around for a while but has not historically been adopted as a commonplace tool in one’s financial picture. Why? Because it can be time-consuming, complex, and not as easy to see the benefit as opposed to your static return on investment percentage. The marriage of technology and investment management has rendered many doubts moot and investors are looking to take advantage.

What is tax-loss harvesting?

Tax loss harvesting is the action of selling positions at a loss to obtain a tax benefit in the future in an attempt to maximize one’s after-tax return. Once sold, the proceeds can then be reinvested in similar positions (e.g. same economic sector, similar metrics such as P/E, P/B, etc.) to maintain your portfolio’s integrity. This periodic process of harvesting losses and then reinvesting proceeds can allow investors to build up a bank of tax losses and ultimately, erode their capital gains tax.

This strategy is not attempting to time the market. Typically, a separately managed account consisting of individual stocks is constructed with the goal of tracking a specific benchmark (e.g. S&P 500, MSCI ACWI). As the prices of the stocks in the portfolio fluctuate, a continual rearrangement of positions occurs by recognizing tax losses from securities that have declined in value. Those losses can then be used to offset capital gains across an investor’s entire balance sheet. By reducing one’s realized capital gains, tax payments are reduced, and after-tax returns are increased, all other things equal.

Why should you consider it?

Tax savings

• For taxpayers who are sitting on large unrealized gains, tax loss harvesting can provide a way to help diversify your concentrated positions and minimize taxes year over year

Growth from after-tax savings

• The reinvestment of tax savings generated from tax loss harvesting compounds over time and can provide a greater likelihood of financial benefit

Taking advantage of volatility

• Over the long term, no one can predict how markets will perform. Employing a successful tax loss harvesting strategy earlier can provide a longer time horizon over which to use volatility as a way to increase after-tax returns

Let’s consider an example (for illustrative purposes only):

Erica is a key executive at a Fortune 100 company and has been accumulating restricted stock for 15 years. Over those 15 years, her portfolio composed of her company’s stock and external positions has risen to a value of $15M. Erica plans to retire in 2024 and would like to diversify her portfolio to minimize her concentrated stock position in retirement.

In January of 2024, Erica decides to sell $5M of securities to buy a second home at a later date and incurs a $3M gain. She also decides in January to employ a tax loss harvesting strategy.  Taking advantage of the normal volatility that occurs during the course of a year, she is able to realize losses equal to 10% of her portfolio value, or $500,000, while likely recognizing a gross return similar to that of the benchmark she targeted.

Had Erica not employed the tax loss harvesting strategy, her capital gains tax would have been around $900k (assumes a combined 30% federal, state, and net investment income effective tax rate on her $3MM of gains). However, because of the tax loss harvesting strategy employed, her payment would be reduced by $150,000 which represents a 3% “added return” on the transaction.

Key assumptions: – Tax rates subject to change, rounded values used in example – No other income nor deductions considered in example – 10% of losses harvested in a portfolio is not guaranteed

Why is it important for your portfolio?

The needs, wants, and aspirations of each individual or family are vastly different. Our goal as advisors is to evaluate those needs, wants, and aspirations and construct, execute, and maintain a plan that encompasses your entire balance sheet. Tax loss harvesting can be a key function in that equation. The numerator of any financial picture is income deriving assets and the denominator is net income eroding liabilities or expenses. Capital gains tax is part of that fraction and tax loss harvesting is an efficient, cost-effective way to minimize your denominator and maximize what matters most to taxable investors—after-tax returns.

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For informational and educational purposes only. Not intended as legal, tax or investment advice. Please consult with your investment adviser before executing any investment strategy. The views and opinions expressed herein, specifically expressions of “we” or “we feel”, are those of the author(s) and do not necessarily reflect the views of Constellation Wealth Advisors, Quadrant Capital Group LLC, or its affiliates, or its other employees. Past performance is not indicative of future results. There is no guarantee of investment results. Constellation Wealth Advisors, LLC is a registered investment adviser. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice. For more information about Constellation Wealth Advisors, including the firm’s Form ADV Part 2A Brochure, please visit https://adviserinfo.sec.gov or contact us at 513.871.5500.