Many investors with taxable accounts (and advisors managing them, for that matter) tend to wait until year-end before looking for tax-loss harvesting opportunities. This can be costly for the investor, as unrealized losses that are available throughout the year may disappear by December.
As with most areas of investing, it is generally advisable to have a tax-loss harvesting plan in place prior to implementing a portfolio. This will ensure that discipline is maintained throughout the investment process.
So what would be a good “rule of thumb” for harvesting losses?
In Larry Swedroe’s book, The Only Guide You’ll Ever Need for the Right Financial Plan, he suggests two hurdles that should be met before engaging in tax-loss harvesting:
For example, suppose an investor purchases $100,000 of iShares S&P/TSX Capped Composite Index Fund (XIC) in their taxable account on January 2, 2012. On June 22, 2012, the value of XIC has dropped to $95,000. Should they harvest the loss?
Answer: Both hurdles suggest that the loss should be realized. Therefore, XIC should be sold and a similar (but not identical) security should be purchased with the proceeds.
Hurdle 1 has been met: There is an absolute dollar loss of $5,000:
$95,000 - $100,000 = |-$5,000| = $5,000
Hurdle 2 has been met: There is a minimum percentage loss of 5%:
[($95,000 / $100,000) – 1] = -5%
As with any rule of thumb, there are going to be exceptions. For example, suppose you have a net capital gain from 2009 that will expire if you don’t offset it with a net capital loss by the end of 2012. In this instance, it may be appropriate to harvest a loss this year even if both of the above hurdles are not met.
If you are a do-it-yourself investor with taxable accounts, ensure that you are checking periodically throughout the year for tax-loss harvesting opportunities. If you work with an advisor, ask them if they have a disciplined process in place to take advantage of these opportunities. If they look puzzled, consider finding another advisor.