Using exchange-traded funds in harvesting losses to offset taxable gains can save investors money.
The "tax loss harvesting" strategy was used extensively over the past few years when the stock market was floundering, according to financial advisers.
In its simplest form, the strategy calls for an investor to sell a stock, bond or mutual fund at a loss, use that loss to offset any gains and buy an ETF that corresponds to the security to maintain market exposure. Investors can sell the ETF after 30 days and buy back the securities sold without violating the wash sale rule in the Internal Revenue Code.
Now that the market has improved, however, some advisers question the need to harvest losses. Investors should have already harvested losses from previous years, and there shouldn't be many losses to be found this year, they say.
not much planned
Dave Fox, director of
portfolio management at Sullivan Bruyette Speros & Blayney Inc., says he doesn't think his company will use the strategy much this year. The McLean, Va., firm, which has about $900 million under management, has used ETFs to harvest losses in the past.
Mr. Fox says that if other investors were diligent about taking losses in previous years, they too shouldn't have to worry much about tax loss harvesting.
Of course, investors aren't always diligent. Even if they are, it is hard to imagine an investor whose portfolio doesn't contain at least some losses.
"In years gone by, we have always done tax loss harvesting in both good years and bad," says Michael Fitzhugh, a principal with Kochis Fitz Tracy Fitzhugh & Gott Inc. in San Francisco, which has about $700 million under management.
He acknowledges that he expects his firm will use ETFs less frequently to harvest tax losses this year than it has during the past couple of years. The company, however, will probably "run a couple of computer queries across our client portfolios to see if there really are opportunities," Mr. Fitzhugh says.
Finding those opportunities will be difficult, especially among mutual funds.
The only fund categories that were down year-to-date through Nov. 10 were
bear market funds (-11.71%) and long-term-government-bond funds (-0. 40%), according to Morningstar Inc. in Chicago.
Of course, there are always funds that underperform their categories, just as there are stocks and bonds that underperform, says Jay Shein, chief executive of Compass Financial Group Inc. in Lighthouse Point, Fla., which manages about $130 million. If losses are attached to underperformers, it may make sense to harvest the losses, he says.
But just identifying the losers isn't enough, Mr. Fitzhugh warns.
For example, if you intend to move cash out of certain securities and into an ETF, you need to understand how such a move may affect the market, he says.
For example, Mr. Fitzhugh says, his firm last year moved about $30 million out of emerging-market securities and into an exchange-traded fund pegged to the MSCI/ EAFE index. That is not the most liquid index, and he says his firm was worried about affecting the price of the ETF, pushing it higher if the firm decided to execute its trade all at once. The sale was done in pieces, however, and Mr. Fitzhugh says his firm was able to get the best price for its clients.
Luckily, he says, he doesn't envision having to move much money into ETFs this year. If an investor has any losses, however, such moves need to be seriously considered, Mr. Fitzhugh says.
