One of the beauties of an automated investment experience is that you can take a hands-off approach and allow Allio’s experienced hedge fund veterans to build a strategic portfolio suited to your goals. One tactical move – much discussed in the financial press during bear markets – is tax-loss harvesting.
Tax-loss harvesting might sound complicated, and it can be confusing when going about it on your own. It is the active method of selling losing stocks to lock in realized losses. Why do that? Well, losses on your investments reduce taxable income by up to $3,000 per year per taxpayer. What’s more, securing losses offset realized gains in other areas of the taxable account, thereby reducing total capital gains taxes owed. The annual strategy, therefore, works in both bull and bear markets so long as there are at least a few dogs in your basket of holdings.
The Tax-Savings Power of Automation
At Allio, we like to think of our advanced automated investment approach as paying for itself through the tax benefits of tax-loss harvesting. With other advisors, annual investment management fees can add up over time – which in effect turns into a significant opportunity cost due to forgoing the magic of compounding. Our clients can use the tax savings from tax-loss harvesting to offset some or all of our small fees.
Allio’s portfolio management technology is designed to target potential tax-loss situations without negatively impacting returns. Our investing app does this daily. Imagine the time-consuming burden of trying to do that on your own.
How Tax-Loss Harvesting Works IRL
Let’s put some numbers to our assertion to help illustrate the point. We’ll say you have 10 positions in a $50,000 portfolio at $5,000 each. Over the course of the year, your holdings collectively rose 10% to $55,000, and Allio took profits worth $3,000 during the year. Rarely does everything come up roses in the investment world, however. Assume three stocks dropped by 10% in a few months – maybe as a result of poor earnings reports from the companies or technical downtrends that evolved.
No matter the reason, Allio can sell those underperformers, which would have losses amounting to $1,500 ($500 each) to offset profits booked on other assets. If you are in the 22% marginal tax bracket, you would generally owe 15% tax on long-term capital gains and pay tax at your marginal rate for short-term profits (gains you make from selling assets held for a year or less). In effect, that $1,500 tax-loss harvest nets a current-year tax savings of up to $330.
Snatching Valuable Losses Without a New Allocation
Another benefit to tactical tax-loss harvesting is that it can be done without making wholesale changes to your allocation. In fact, simply rebalancing back to your strategic asset allocation might include taking some losses to offset gains elsewhere in your account. That might sound counterintuitive since rebalancing often means trimming winners and buying losers. But here is where a little magic happens (it’s not really magic, just thoughtful portfolio management). Read on.
Being Tax Savvy with Allio
In another hypothetical, picture a portfolio with a few exchange-traded funds (ETFs) in your account. One of them goes through a tough stretch and declines by 10%. Allio can sell that fund, buy a similar (but not substantially identical) ETF and book the loss to capture the tax benefit. That tactic can be done easier than ever these days with so many funds out there, many of which do nearly the same thing. Consider all the highly correlated large-cap growth ETFs or even real estate sector products. This is yet another approach to building up losses so you come out as a winner.
A Customized Investment Plan
Do you live in a high-tax state? If so, then active investing on your own can be even more costly. We don't have to tell you that if you traded meme stocks or crypto independently in the last few years. For folks who live in states that tax investment gains, then our advanced tax-loss harvesting techniques are even more valuable.
Minimizing realized capital gains, particularly short-term profits, is paramount depending on where you live. Allio tailors investment plans to each investor, and that includes an assessment of potential tax implications at the state level. While we are not tax advisors, careful portfolio management with a nod to tax impacts is a key consideration.
Two More Tax Nuggets of Wisdom
One of the cool things about tax-loss harvesting is that it’s not a “use it or lose it” kind of deal. You can roll over losses to future years. For instance, if we generated $8,000 of realized losses in one year, then you could take a $3,000 capital loss deduction in the current year, $3,000 the following year, and $2,000 the year after that. But one thing we must be cognizant of is the dreaded “wash sale.”
A wash sale is a disallowed capital loss. It happens when you sell a security at a loss, then repurchase it within a 30-day window. This trips up many traders who go in and out of stocks during the day or throughout a few weeks. Allio’s technology is designed to avoid wash sales when possible.
A final point to underscore the benefits of tax-loss harvesting (this one requires you to know a little finance and investing 101): There is a concept known as the “time value of money.” It postulates that a dollar today is worth more than a dollar tomorrow (due to inflation and since you can invest that dollar now and grow it over time). Makes sense, right?
Here’s how it applies to tax-loss harvesting: Allio’s software can book short-term losses to offset otherwise costly short-term capital gains. Since short-term profits are taxed at the taxpayer’s potentially high marginal rate, it becomes imperative to avoid paying that when possible. By executing short-term loss trades to offset those short-term gains, we essentially defer capital gains to the long-term category. For many folks, a long-term capital gain can result in a 0% tax rate (though the maximum is 20%).
While some robo-advisors out there preach the benefits of tax-loss harvesting, Allio recognizes that it’s not right for everyone - we can even harvest gains for young investors so they can seize the best tax rate of all: 0%.
The Bottom Line
Advanced automated tax-loss harvesting tailored to each of our client’s economic situations is a tool Allio uses to help our investors save money each year. We find that its financial advantage more than offsets our small annual fees. Our global macro portfolios are built not only to benefit from changing variables across many asset classes, but we pride ourselves on minimizing our members’ tax burdens. Tax-efficient investing is a key aspect of effective long-term portfolio management and helps our clients keep more of what’s theirs, making their journey to financial independence faster.