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In this post, we talk through strategies around stock losses and tax loss harvesting. While it’s never fun to see your company’s stock trading at a substantial loss, you can use it to your advantage moving forward if you sell & harvest the loss.
Once you’ve sold it, you have “realized or “harvested” the tax loss and can now use it to your advantage in future tax years as a potential offset to future capital gains or a small amount of income. Fidelity has a great piece talking through the rules and considerations determining what the realized loss can be used to offset.
Tax Loss Harvesting losses allows you to strategically build your portfolio for a greater after-tax return.
Higher growth funds can then be located in your brokerage account. This allows you to offset potentially high gains with the prior tax loss.
It’s never fun to see a stock you own drop in value. Unfortunately for many people in Houston, you’ve seen a lot of this in the last few years. But can your current stock losses be an opportunity? If you capture the loss, they certainly can be. In this post, let’s talk about how to capture stock losses and how to use them as a “tax asset” in your portfolio moving forward.
As a long-term investor, you want to see your money compounding. If the global stock market returns 10% per year, you want to make sure you capture as much of that return as possible. What are the main obstacles in this pursuit?
If you have $50,000 in a taxable brokerage account and it grows to $100,000, the tax rate owed on that gain matters.
As the image shows, the type of account you own these assets in matters. Let’s assume it’s a non-retirement brokerage account. In this scenario, you may be staring at capital gains. Or tax policy changes and you could owe substantially more in taxes. Or you already captured a tax loss to offset the gain completely.
The standard protocol for many Wall Street firms looks like this.
A client goes to an investment firm to have assets managed and takes a basic risk tolerance survey.
Investment firm shoves the client’s assets into one of 5 canned models that every client is invested in.
Let’s pretend it’s a 60% stock 40% bond mix–the investment firm puts the client’s pre-tax IRA, brokerage, and Roth accounts all in the canned 60/40 portfolio.
There isn’t necessarily a problem with a 60/40 portfolio. But there are a couple of problems here. Let’s talk through them:
This is the extent of the value many large investment firms provide. So, be very mindful of the all-in fees you’re paying for this service. Remember, Vanguard can build you a great portfolio and do basic retirement planning with a CFP professional for .3% per year.
One easy metric to help understand if your advisor is worth more than Vanguard’s ultra-low fees: Have they asked to review your tax return every year? Have they reviewed your estate plan? If your advisor hasn’t combed through your tax return, I have no idea what you’re paying for–and it likely costs you far more than you know.
Canned model portfolios may require your current portfolio to be sold before implementation. This doesn’t matter in a Roth or IRA. But it can matter a great deal in a non-retirement brokerage account. If you have a $500,000 unrealized gain in your brokerage account, is this canned portfolio really worth a six-figure tax bill?
Here is the biggest problem. A Roth IRA shouldn’t have a 60/40 portfolio! This is borderline insane–and lazy. Why would you own cash and bonds in a tax-free account? With interest rates as low as they are, you might only see a 2% return in this 40% section of your portfolio. So, why would you put any of that in a Roth account? Why wouldn’t you place your highest growth assets in a Roth account?
And if you have a substantial tax loss that offsets future gains in the brokerage account, put “growth-ier” assets there as well. Simply put: locate your “growth-iest” assets in the accounts that reward you for growth.
When we build and manage portfolios, we’re mindful of asset location. Now let’s talk more about the basic fundamentals of harvesting a tax loss.
This is kind of a trick question. As I’ve said extensively, it is truly absurd to try and time the market. If your portfolio is down, but it’s a solid, well-diversified portfolio, you should likely stay put. Your concern should be building wealth and seeing gains over 20 years, not 20 days.
However, there is a big difference between your entire portfolio and one individual stock. One individual stock should carry pessimism more than optimism. There is plenty of reason to believe that the global stock market will do well over the next 20+ years. Individual companies do not have the same odds. The S&P 500 has done historically well over the past 12 years. Still, hundreds of individual companies in the S&P 500 have done much worse than the index as a whole.
Remember, while bad companies obviously tend to struggle, bad things also happen to good companies.
So, what should you do when an individual stock is down?
Sell it!
The reason you want to sell an individual stock is to “capture” the loss. If you own Apache or Schlumberger and are down $100,000, you haven’t captured the loss—you cannot use it to your advantage yet. In order to use this $100,000 loss, you have to sell it.
If you’re adamant about continuing to own a particular stock to see it recover, you can do that. Simply wait 30 days, and you can repurchase the stock. You could sell the stock and capture the loss, purchase an Oil & Gas ETF to have similar exposure, and then repurchase the exact stock after 30 days to avoid the wash sale rule.
In this scenario, you may still own the stock or not. But, you have the tax asset. Harvesting or capturing the loss allows you to position your portfolio for greater after-tax returns.
As with all of our content, this is educational and does not constitute an advisory relationship. If you’re looking for specific advise, you can contact us here.
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