My portfolio consists of 5 account classes:
- Taxable (post tax)
- TIRA/401K (pre-tax)
- Roth IRA (No tax)
- Tax Loss Harvest (tax loss)
- Social Security (taxable annuity)
Each of these fit into and support my retirement cash flow differently. In the taxable account I hold stocks funds and ETF’s which are distributed according various investing styles:
- US equities
- Emerging markets
- Low Beta
Things that throw off dividends and interest that would increase my tax load like bonds real estate and gold are in the TIRA accounts as well as tax inefficient equities.
I’m loading up the Roth with things from my TIRA and I’m transferring the things with highest volatility (risk) first. In a down year high volatility means greatest loss in value so the transfer cost (ordinary income taxes) is minimized and I can transfer the the most property for the least cost. Homey likes that. The least volatile assets don’t change value that much so no rush to move them. In fact since bonds don’t change much and throw off interest, I decided to not move them at all, let them RMD and use that as a retirement annuity income. I’ve written about all of this before. My accounts are invested according to Fama French efficient markets theory which uses the 3 factor long term tilts to try and tease out some extra return. 2 factors are missing in the classic Fama French model Momentum and Low Beta, so I add some momentum and low beta ETF’s and funds to round out the diversity party.
My adviser was reviewing my portfolio and noticed the momentum assets were underwater (as to be expected in a down turn) One ETF is the best in that class and another fund was performing less than optimally so we decided to combine the two. Since the assets are underwater their sale would allow tax loss harvesting. TLH is a way to essentially pre-pay your future capital gain taxes, by applying capital loss to the tax bill. It works a little like depreciation on a property or a business where you can lock in a loss to offset a future capital gain. It’s a very powerful tool. The rule is: the money you get to keep is whatever is left after the tax man pillages the funds so TLH is like hiding some money under the bed. In my case I’ve harvested enough losses by selling in down markets, to offset hundreds of thousands in gains in my taxable accounts. It effectively turns my taxable account into a Roth up to the limit of the harvested loss, and those saved taxes are no joke. You can buy actual hamburgers with those savings. But wait there’s more!
I used the TLH to combine taxable assets with no tax consequence and a future tax savings. Since both funds were down and had losses to harvest I wanted to maximize my take and acquire the loss from both funds, BUT I then wanted to re-purchase the better fund with all of the proceeds from the sale and the IRS doesn’t allow that. If you want to buy the same asset you have to wait 31 days, and suffer any market consequence while you’re sitting on the side line. The other alternative is to invest in some other asset that is substantially different than the first which you can do immediately and stay fully invested. I know… first world problems but then I live in the first world.
So what we did was sell about 100K of the momentum funds, into the rally, and I collected 20K in LTH and put that in the TLH bank to use at a future date. This is why I consider TLH a separate asset class. It is essentially negatively correlated to equities in terms of value. As equities go down my future tax relief goes up. I don’t like equities going down but may as well grab the value if it presents. So my 100K is sitting in cash and a reminder in the calendar to remind us to reinvest in the better ETF at the end of January, I own that ETF in my Roth and TIRA as well so I’m exposed anyway if the market explodes, but not quite as much as I will be in 31 days. I may even have a chance to buy in at a lower cost if the market continues to fade. So that’s the bet. It works like selling a covered put where I bet the market is likely going down or at least not advancing for 31 days. My risk premium is the locked in 20K TLH and my risk is I have to buy back the ETF at a higher price than I sold it for. Since I sold into a 1000 point rally that improves the chances of the trade working out to the positive. Ya ya I know you can’t beat the market, some joker wrote a study, so just buy low cost index funds…
I play a lottery called Lucky Money every week. It’s payout is limited to 2M but it’s odds are 125x better than Power Ball and a ticket is only $1 not $2. So I get 125x better odds for half the money. The elegance of the concept tickles me enough to get me to cough up the buck. I’ve probably revealed too much.
2 Replies to “Tax Loss Harvest”
I love your break down of the portfolios. We think eerily alike. I am VERY interested to watch your retirement progression. I think I will learn a lot from this.
I would be concerned retiring without some “annuity like” portfolio. I will use my RMD account for fixed income instruments as well.
I have scoured the internet and spoken to many “professionals” and have yet to see a better plan than this.
I suppose a DB Plan would have been better. However I also have only been an employee for 1 year. That was enough for me thanks.
I know different peeps same brain, scary. I guess it depends on how a DB is amortized. $300/mo probably seemed like a lot in 1960.
Good to see you!