- Not all equity sectors, styles and market caps have bounced back from the late-March lows.
- This presents the opportunity to sell investments in taxable accounts that have lost value to offset capital gains and help to reduce taxes.
With the S&P 500 hovering near all-time highs for now, not all equity sectors, styles and market caps have bounced back from the late-March lows. This provides investors with the opportunity to sell investments in taxable accounts that have lost value to offset capital gains and help to reduce taxes. With tax-loss harvesting, if your losses exceed your gains at year-end (or if there are no gains), losses can offset up to $3,000 in noninvestment income, even though that is often taxed at a higher tax rate than capital gains are. Losses greater than $3,000 carry forward to offset capital gains and ordinary income over your lifetime.
Many investors begin tax-loss harvesting by identifying which asset classes have experienced losses. However, other factors also can impact the tax efficiency of nonqualified accounts. For instance, Which fund structure is most tax efficient? is an often-overlooked question.
ETFs are generally more tax efficient than mutual funds are because of how the funds handle investor outflows (and inflows). When mutual funds experience redemptions, the portfolio manager must sell off enough securities so that the cash levels of the fund can cover the redemptions. When the securities are sold, that triggers a potential capital event, as any taxable gains would be passed onto the shareholder. ETFs handle redemptions quite differently, as those transactions are centered on the underlying fund securities — not cash — thereby dramatically reducing the chance of a capital event. To meet ETF redemptions, an intermediary called an authorized participant (AP) returns the ETF shares to the sponsor in exchange for a basket of the funds’ underlying securities. The AP then liquidates the basket of securities and transfers the sale proceeds to the original ETF shareholder. Known as creation and redemption, this process sets ETFs apart from mutual funds.
As a result of these differences, due to their reliance on cash to meet redemptions, mutual funds — in general — have a higher probability of distributing capital gains to shareholders than ETFs do.
1 Morningstar, 12/31/2019 to 09/30/2020.
2 Morningstar, 12/31/2019 to 09/30/2020.
3 Morningstar, as of 12/31/2019. Calculations by SPDR Americas Research.
4 Bloomberg Finance L.P., 12/31/2019 to 10/13/2020.
5 Morningstar, 1/1/2010 to 12/31/2019. Calculations by SPDR Americas Research. One-year rolling windows. One-month moving step. Analyzed all US mutual funds in the Large Value Morningstar Category (oldest share class). Includes obsolete funds. Excess return measured relative to each fund’s primary prospectus benchmark.
6 Morningstar, 1/1/2010 to 12/31/2019. Calculations by SPDR Americas Research. One-year rolling windows. One-month moving step. Analyzed all US mutual funds in the Large Value Morningstar Category (oldest share class). Includes obsolete funds. Excess return measured relative to each fund’s primary prospectus benchmark.
7 Morningstar, as of 09/11/2020. Calculations by SPDR Americas Research. US-Listed ETFs and oldest share class mutual funds were analyzed in the respective Morningstar Categories; 139 funds ranked in Mid-Cap Value; 255 funds ranked in Small Blend; 91 funds ranked in US Real Estate.
Basis Point (bp)
A unit of measure for interest rates, investment performance, pricing of investment services and other percentages in finance. One basis point is equal to one-hundredth of one percent, or 0.01%.
Russell 1000® Growth Index
A benchmark measuring performance of the portion of the large-cap segment of the US equity universe that exhibits strong growth characteristics.
Russell 1000® Value Index
A benchmark measuring performance of the portion of the large-cap segment of the US equity universe that exhibits strong value characteristics.
Originally Posted on October 16, 2020 – Look Beyond the Losses When Tax-Loss Harvesting
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