Image by Mid Journey
By Kerri Quinn
Head of Index Solutions
Introduction
As we approach the end of 2024, with the S&P 500 up over 26% year-to-date and on track for its best performance since 2021, many investors are riding high on those gains. Take NVIDIA for example- with a staggering one year return of 225.6% as of November 2024, many portfolios have seen substantial appreciation. While these gains are welcome, they make tax-efficient investing strategies more important than ever, like tax loss harvesting. These strategies aren’t just for year-end. They can and should be implemented throughout the year to maximize their benefits.
Understanding Tax Loss Harvesting
Tax loss harvesting is a powerful strategy that can help offset these substantial gains. It involves strategically selling investments at a loss and is particularly effective in reducing short-term gains, which are taxed at higher rates than long-term gains. The key is reinvesting the proceeds from the sale into a similar security to maintain overall market exposure.
Why Year-Round Tax Loss Harvesting Makes Sense
Many investors mistakenly wait until year-end to harvest losses. However, doing so can mean missing out on valuable mid-year opportunities. Market volatility throughout the year provides multiple chances to capture losses and optimize tax outcomes. Think of tax loss harvesting like grocery shopping. You could wait until your pantry is completely empty, or you can replenish strategically when items are on sale. The same goes for capturing losses- waiting until year-end means potentially missing valuable opportunities throughout the year.
For example, the S&P500 is up nearly 28% YTD as of the publication of this post. And yet, 361 securities from the S&P500 (nearly 72% of the index) were down at least 5% at some point during the year! Waiting until the end of the year would mean you are leaving all of these tax loss harvesting opportunities on the table.
Let’s Break It Down: The NVIDIA Example
Imagine your client’s portfolio has some NVIDIA stock, and its 225.6% return has now generated a $225,000 gain. That’s amazing- but it’s also now a big taxable event. Now, say your client has $75,000 in losses from other investments that didn’t quite pan out as planned. By selling those underperformers, you can harvest the losses and offset your client’s NVIDIA gains.
You can now reinvest the proceeds from selling those losses into similar securities, so that your client’s portfolio is still in line with the chosen benchmark. Your client will love saving money on taxes just as much as they love seeing those big gains in their accounts.
Of course when you sell securities at a loss and buy other similar securities back, it’s critical to consider the implications of wash sales. An effective tax loss harvesting platform will always take that into account, while also minimizing your portfolio’s deviation from its target.
Benefits of Direct Indexing in Tax Optimization
1. Offset Big Gains: This strategy is going to be a lifesaver in a year like 2024, where strong market performance and standout stocks like NVIDIA have boosted portfolios but also created big taxable events.
2. Tackle Short-Term Gains First: Since short-term gains are taxed at higher rates, using harvested losses can offset those short-term gains and give your clients’ more bang for their buck.
3. Build a Tax Loss Reserve: Excess losses that are not offset by capital gains can be accumulated up to $3,000 of ordinary income annually. The remaining losses can be carried forward indefinitely. These losses can be applied to future gains or income, creating a valuable tax-saving tool for years to come.
Beyond Year-End Planning
Markets naturally create tax loss harvesting opportunities throughout the year, not just in December. These opportunities arise from multiple sources:
- Sector rotations causing temporary price declines
- Interest rate changes impacting different sectors unevenly
- Company-specific challenges (idiosyncratic risks) like management changes, competitive pressures, or regulatory issues
The key is recognizing that tax loss harvesting isn’t just a year-end or bear market strategy. Even in strong bull markets like 2024, regular monitoring can identify valuable harvesting opportunities to reduce tax liability and build tax loss reserves. This approach effectively transforms normal market volatility into a tax advantage while maintaining your client’s long-term investment strategy.
At Alphathena, we understand that tax loss harvesting is a complex, year-round process that requires constant monitoring and careful execution. Our sophisticated platform automates this process, continuously scanning for tax loss harvesting opportunities while carefully avoiding wash sales and maintaining your target portfolio allocation.
With Alphathena’s direct indexing solution, you can help your clients capture tax alpha throughout the year, not just during December.
Want to learn more about implementing systematic tax loss harvesting for your clients? Contact us today to see how Alphathena can help enhance your tax-efficient investment strategy.
