Full Transcript
[00:00] It's Brian Preston, the money guy. When does it make sense to do loss harvesting? When is it a prudent and practical strategy? Well, before we talk about when it does make sense,
[00:12] let's talk about some of the times when it does not make sense. And here's the obvious one. It doesn't make sense to try to do any sort of loss harvesting if you don't have any losses. If you've been someone who's been dollar cost averaging
[00:24] for the past couple of years on a low cost US based index fund, odds are, even though this year the market is down, your holding is probably still up. You probably still have embedded gains in that.
[00:36] So you have to actually have losses in order to be able to loss harvest. Yeah, so that's something definitely to pay attention to. The other thing is, and now hopefully most of you are paying attention to transaction fees. This is only something I see with bigger accounts where you're trying to get into asset allocators
[00:52] or different asset classes. but typical equities should not have a lot of transaction fees. But let's just follow me on this journey in this example. I don't want you trying to harvest $300 to $1,000 worth of losses,
[01:07] but then paying a $35 to $50 transaction fee. That just seems like you're working against yourself with the cost because as you'll see later, you might do these transactions multiple times.
[01:19] So transaction costs definitely should be a component that you're paying attention to. Now, let me share with you, if you do have a large portfolio, yes, it might be worth paying the transaction fees. But for a lot of the smaller accounts, don't just do it because you want to be doing something sophisticated,
[01:36] but not actually get the benefit of it. So pay attention to those transaction fees. And then the last thing, and again, this is where sometimes we, because we live in this, we take this as a given, but I think it's important to say, you can only loss harvest inside of taxable accounts.
[01:51] You cannot loss harvest inside of a Roth IRA or inside of a rollover IRA or a SEPI or a simple or a 401k. It only makes sense to do loss harvesting inside of taxable vehicles So if you don have an after account if you don have that third bucket in your portfolio loss harvesting is not something that will benefit you
[02:12] It's not something you should be thinking about. Yeah, I think it's also important. If you go to moneyguy.com slash resources, financial order of operations, there's a reason we do front-load you on the retirement accounts for all those tax savings because you're prioritizing the Roth,
[02:26] you're prioritizing the 401k match. There is a chance that some of you in your 20s and 30s won't have a lot of opportunity, but it is something you still should be very aware of. And that's why I'm glad that we're transitioning into what are the reasons why it does make sense.
[02:41] So as you get to step seven of the financial order of operations, you get to hyperaccumulation, you can pay attention to the three buckets because this will be very valuable to you. So these are the things that you need in order for it to make sense. You need
[02:54] a taxable portfolio, an after-tax portfolio with meaningful losses. You actually have some losses you can go in there and grab. And you need those losses to exist inside of easily substitutable
[03:08] holdings. And we're going to talk more about this in a minute. It's not uncommon. Maybe you have a fund in your portfolio that does something very unique and it serves a very unique and specific purpose. And if you were to sell out of that fund or move away from that manager, it would be
[03:21] difficult for you to replace that exposure. Well, we all know markets can move and they can move quickly. And what you don't want to do is move out of a fund that you love into a fund that maybe you don't love or a sub bar. The market rebounds rapidly and has that 12, 14% run up inside of the
[03:38] first month. And then you're trapped inside that fund that you did not want to be in. So you want to make sure you have a viable substitute for any holding that you are loss harvesting. To say that a little bit differently, not every holding should be loss harvested. Just because you have a loss
[03:54] does not mean you should harvest it. You only want to harvest those losses inside of holdings that are easily replicable across another set of holdings. Another indicator that this might really make sense to you is if you're charitably minded.
[04:08] You know Bo started off this segment talking about that if you been investing for over three to four years more than likely your portfolio especially if it index funds it still a gain even with the recent market volatility just because you been invested you had enough gains
[04:23] Because remember, we know markets lose money two out of 10 years. So that eight out of 10 years that it's positive, you're making money off of that. And there's a chance that you're not going negative to even use this tool. But if you're charitably minded, we have a strategy in a minute we're going to share with you where you can actually over time increase your basis by harnessing the power of loss harvesting with charitable giving strategies so that you can, even if you are a long-term investor who's been doing this 3, 4, 5, 10, 20 years, there's a way to push your basis up in a strategic way.
[04:58] So let's talk about a very simple example. Everything we've talked about here has been sort of theoretical and academic. Let's look at a real-life example. So let's say that Hank has $100,000 invested in the Vanguard small cap index on January 1st,
[05:13] and this specific holding is held inside of his after-tax account. Well, the markets do what sometime markets do, and let's say that by June 30th, that holding is down 20% by June 30th.
[05:26] Hank says, you know what? I'm going to go loss harvest. I'm going to sell the Vanguard small cap index, and I'm going to go buy the iShares small cap ETF. I look to see what indices they track and what the underlying holdings are, and I've determined that they are materially different
[05:41] enough to justify replacement. They are not substantially identical. So I'm going to sell VB, and I'm going to go buy IJR, and I'm going to lock in those $20,000 in losses. Well,
[05:53] then the market gains back 25%. So it lost 20, then it gains back 25. And because they are in the same asset class, they move relatively close. We're going to talk about that in a second. Hank actually ends up back at the same point he would have been had he did
[06:07] nothing. He had 100,000. He wrote it down to 80,000. He wrote it back up to 100,000. But because he employed loss harvesting he now has in losses that he clipped at the bottom that he can use to offset any capital gains that he has this year He can offset up to of ordinary income
[06:26] And if he doesn't use all of his losses, he can carry them forward indefinitely. He did not change his investment strategy. He did not change his investment structure. He simply took advantage of the opportunity that was there via loss harvesting.
[06:39] Well, I think somebody who's never done this, man, there was a lot of, there were some transactions that occurred there. There were some calories burned to do this. What's the benefit? Because if you started at $100,000, as you guys just showed the round trip,
[06:52] you ended up at the end of the year with $100,000. Why even go through all this work? And here's the point I want to make. I covered this earlier. That $3,000 that everyone would get to take to offset ordinary income
[07:05] of capital losses, that could be in your pocket $1,000. So at a minimum, that $20,000 loss could be $1,000. So instead of having $100,000 at the beginning of the year, now you have $101,000 if you think about it in terms of after the tax benefits.
[07:21] But there are people out there, as I shared earlier also, you might have other income sources. You did an installment sale where there's capital gains coming in over a long period of time. You sold some property.
[07:34] This is going to be huge. If you had a $20,000 loss and you had that income coming in, if you're in those higher tax brackets, if you think state income taxes, federal income taxes, there is a chance that out of that $20,000 loss, you actually get to put $10,000 in your pocket because it could be a 50% tax benefit for the highest income tax individuals.
[07:57] This is powerful. Now you're starting to lick your chops a little bit and going, man, I went round trip, have the exact same amount of money, but just by doing this simple transaction, I have an additional $10,000.
[08:09] Now I'm at $110,000 because I actually did the hard work of turning this tax strategy into a lower taxable situation for me and my family.