By Solomon G. Teller, CFA, Chief Investment Strategist, Green Harvest Asset Management
As we discussed in our study, capital gains taxes are not inevitable, particularly for index-oriented investors.1 Moreover, even if investors sell their portfolios at a gain, they can benefit from the value of tax deferral. Consider that in the last five years, the S&P 500® index has returned 138% through the end of October. This means that an investor who reduced tax cost five years ago, then reinvested those savings in the S&P 500, then deferred recognition of gains until today would have well more than doubled their initial tax savings.
To put numbers on this, in 2015, mutual funds distributed an average of 2.42% of assets in capital gains. An average $1,000,000 mutual fund portfolio would have received about $24,200 in taxable gains for a tax cost of up to $10,500 (assuming the highest federal tax bracket on short term gains at that time). By offsetting that cost using tax loss harvesting (TLH) and keeping those savings invested in the S&P 500, that $10,500 in deferred cost could have added nearly $25,000 in additional growth to a $1 million portfolio over the last 5 years – see chart. A dollar saved was more than two dollars earned, and that’s without any additional tax planning.
More broadly, our study found that, even assuming full portfolio liquidation after each rolling five-year period over the past 20 years, a TLH strategy applied to S&P 500 portfolios could still provide an average of 0.9% per year of additional return versus the non-TLH portfolios.2
The power of deferral can be substantial. Harness this power to improve after-tax returns for 2022 and beyond.
1 Investors should understand the other components of tax-beneficial investing that incorporates TLH – see study (page 124) for details.
2 Benefit is due to difference between short-term and long-term rates as well as value of deferral. See here for details and assumptions in study.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when the portfolio is liquidated. Current performance may be higher or lower than that quoted. Performance of an index is not illustrative of any particular investment. It is not possible to invest directly in an index.
GHAM does not provide tax advice and does not employ a Certified Public Accountant on its staff. We work with outside accounting firms and tax counsel that provide guidance and updates on relevant tax law, and we have reviewed the tax treatment of our transaction structures with those professional advisors. Based on those reviews, GHAM is satisfied that our structures support the desired tax results, but we urge clients to consult their own legal and tax advisors regarding the tax treatment of the transactions effected in their GHAM account. Such transactions include ETFs. Federal, state and local tax laws are subject to change. GHAM is not responsible for providing clients updates on any changes in tax laws, rules or statutes. Clients remain fully responsible for their own tax positions. Although GHAM does not provide tax, legal or accounting advice, we stand ready to assist clients and their advisors in reviewing the relevant tax rules.
Reasons to harvest capital losses, sources of capital gains and the suggestion that mutual funds distribute capital gains are for illustrative purposes only. The availability of tax alpha is highly dependent upon the initial date and time of investment as well as market direction and security volatility during the investment period. Tax loss harvesting outcomes may vary greatly for clients who invest on different days, weeks, months and all other time periods. A client’s tax alpha will depend on the client’s individual circumstances, which are outside of GHAM’s knowledge and control. All performance and tax benefit capture figures are derived from data provided from multiple third-party sources. All estimates were created with the benefit of hindsight and may not be achieved in a live account. The data received by GHAM is unaudited and its reliability and accuracy is not guaranteed.
This material is not intended to be relied upon as legal, investment or tax advice in any form or for any specific client. The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person. All investments carry a certain degree of risk, and there is no assurance that an investment will perform as expected over any period of time.
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