Tax Loss Harvesting Explained

Tax loss harvesting is a common topic in investor conversations when looking for tax reductions. Who can utilize this strategy? How does it work? We will cover all those questions and more! Harry Figgie, Partner & Wealth Advisor at Greenwich Wealth Management joins Cassidy Clement to discuss.

Summary – Cents of Security Podcasts Ep. 98

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement 

Welcome back to the Cents of Security Podcast. I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers, and today I’m your host for the podcast. Our guest is Harry Figgie, Partner and Wealth Advisor at Greenwich Wealth Management. 

Tax loss harvesting is a common topic in investor conversations when looking for tax reductions. But who can utilize the strategy? How does it work? We’re going to cover all of that and more. Welcome to the program, Harry. 

Harry Figgie 

Thank you, Cassidy. Nice to be a part of the program. 

Cassidy Clement 

Yeah, of course. Since this is your first episode with us, why don’t you explain to the listeners a little bit about how you got started in the industry and a little bit about your background? 

Harry Figgie 

Sure. I’m going on my 16th year here at Greenwich Wealth Management as an advisor and, more recently, partner of the firm. I had the unfortunate timing of graduating just shortly before the Great Financial Crisis. I got my start on MBS bond trading—the investments that were credited with ruining the world at the time. So that was pretty short-lived. I did a small non-investment-related stint at Bridgewater Associates until I found my way to Greenwich Wealth Management, where I’ve been ever since and hope that it’s… 

Cassidy Clement 

Yes, mortgage-backed securities—ah, one of the vocab words of the late 2000s there. Today, we’re gonna talk about tax loss harvesting. The markets are relatively volatile, and I think many people are looking at the tax refunds they’ve hopefully recently gotten and then gone, “Oh my goodness. Wait a second. The next year doesn’t look as advantageous.” 

So when we’re talking about this, what exactly is tax loss harvesting? And is it really something that’s more for day-to-day traders, or is it for long-term investors? 

Harry Figgie 

Yep. So let me answer the part of your question and then I’m gonna give you a little bit of background on my firm and how and why we utilize it. 

Tax loss harvesting, definitionally, is pretty straightforward, right? You make an investment, buy it at a price, it’s trading below that purchase price, and you sell it at a loss—then that generates what’s called a tax loss. That tax loss can be used to offset other tax gains, potentially some taxable income, or be used as a loss carryforward. The act of selling the security at a loss locks in that loss. 

Now, tax loss harvesting as an investment strategy—there’s a second component, and that’s the critical component, and that is reinvesting in a security with a similar return profile. If you don’t do the second part and you just sell at a loss, yes, you’ve generated a taxable loss and that will help you, but that’s not an investment strategy—that’s managing a position. If you sell it at a loss, wait, or do something like that, that becomes market timing. And both market timing and taking a position are strategies in and of themselves, but it’s not loss harvesting per se. Does that make sense? 

Cassidy Clement 

So that definition works in the sense of what we’re talking about today. But when it comes down to the actual strategies that it’s integrated into—or maybe the type of investor—is it for anyone to utilize, or is it more so for a longer-term strategy? And some people look at it as… sometimes it’s labeled even as, like, the consolation prize for bad picks. 

Harry Figgie 

I can see the consolation prize for bad picks, but no—tax loss harvesting is a defined strategy. Theoretically, anybody could do it. It is challenging if you are a more novice investor—and it can be challenging for professionals. It’s that second component that defines tax loss harvesting—the reinvestment component—where the challenge is for more retail or more novice investors, the sort of pitfalls that they run into. 

And let me explain why. If you buy a position and you sell it at a loss, you have to then reinvest those proceeds simultaneously—or effectively simultaneously—in an investment that has the same or very similar return characteristics. Ideally, it would be something in the same sector, something that has similar market reactions, things like that. And doing that level of analysis is really technical and challenging. It’s not as easy as “sell Apple and buy Amazon” or “sell Verizon and buy AT&T”—something like that. 

There’s also a lot of tax rules, compliance, wash sale compliance—things like that. They can be very difficult if you’re not familiar with them. So I would say yes, anybody can theoretically do it if you can trade, but it’s usually best left to a professional and somebody that specializes in tax loss harvesting. 

Cassidy Clement 

Yeah, and I mean there are so many layers of rules, of course, when it comes to taxation, but there’s also the layer of complexity—which is how are you going to pivot after you make a decision to sell? So that kind of leads me into my next question, which is the pros and cons of it. Initially, you may think, “I had a loss. I’m going to try to make the most of that,” and we’re going to see how that goes. But there’s a lot more to it. Are there certain pros and cons that people may not think about, or things that are surface level that don’t always get discussed? 

Harry Figgie 

On Greenwich Wealth Management—my firm, how we operate, and how we use tax loss harvesting—and potentially that’ll help frame the answer for the pros and cons and maybe shed a little bit more light on your second question. 

Greenwich Wealth Management—Registered Investment Advisor, SEC Registered Investment Advisor—we manage about $2.7 billion in regulatory assets under management as of our last… we have, more or less, call it 500 client accounts spread across 11 investment professionals. So this level of concentration allows us to create really customized and bespoke [portfolios] for our clients, which range from your everyday sort of clients—like my mother-in-law—all the way up to ultra-high-net-worth individuals, charities, foundations, things like that. 

What we try to do is very firm. So our strategy, generally speaking, is to actively manage passive investments. Passive investment would be something like an S&P 500 ETF—broadly diversified securities, often index-based—and what we try to do is incremental improvement over what you would get. And that’s how we deliver value to our clients. So things like tax loss harvesting, how we weight different portfolios, security selection… 

It’s one of the reasons we really love IBKR as a custodian—cheaper margin, higher cash interest rates, stock yield enhancement. But one of the strategies that we utilize is this tax loss harvesting, because it really can lead to long-term outperformance. 

So if you put all these things that are a little bit better—a little bit better, a little bit cheaper, a little bit faster—and compound those basis points over a really long period of time, that outperformance becomes really meaningful. 

And so that was a kind of a sideways way of getting to the pros and the cons. So the pros of tax loss harvesting are tax alpha. It’s something that’s measurable and definable. At the end of the day, money’s fungible, right? So whether you’re saving it on your taxes or it’s showing up in your account, it doesn’t really matter. That’s extra dollars in your pocket. And that’s the way I look at it. 

But in order to effectively tax loss harvest—and take that away from a consolation prize from a bad pick—you have to systematically do it over a very long period of time to have it be a meaningful strategy. Doing it meaningfully over a long period of time can become challenging. 

If you think back to the bull market run up until January of this year, February of this year, as stocks go higher and higher and the markets move higher and higher, the strategy can atrophy, right? You run out of losses to harvest over a certain period of time. 

So professionals that engage in tax loss harvesting—let’s say you want to replicate the performance of the S&P 500—you wouldn’t necessarily buy all 500 stocks. You might buy a representative basket—enough to have a deep enough bench so when you sell a Verizon or you sell an Apple or something, you have a stock that you can put in there, avoid the wash sale rule, rinse and repeat, and keep this strategy going over a long period of time. 

Tax loss harvesting on a one-off can make sense, but really, if you want it to be a strategy that adds measurable alpha over a long period of time, there are a lot of considerations that I just don’t think your average retail investor can do without the assistance of a professional. 

Cassidy Clement 

Yeah, a lot of people will look toward this as a potential for a portfolio rebalance or, outside of recouping losses, some ways to help offset it. I’m just curious—how do you usually answer the question of people saying, “Okay, I do have the opportunity to do this with someone who’s more of an advisor or somebody more professional to help me utilize tax loss investing. But is there a potential for missing out on future gains?” How do you weigh the opportunity risk? I’m just curious from your perspective as somebody who’s managed larger funds and more homestyle funds or personal funds. 

Harry Figgie 

That’s a great question, and that always—that’s one of the psychology aspects that makes tax loss harvesting really tricky. In order to do this effectively, first of all, it has to be systematic. You have to be dispassionate about it. 

So, you know, if you are a longtime holder of, say, Nvidia—maybe you don’t have any taxes that you can use, but use that as an example—that’s a stock that people feel near and dear to. They don’t necessarily want to sell it. Or if they do decide to sell it, they worry: “Is Taiwan Semi,” or whatever the closest analog is, “going to give the same upside?” Those types of considerations—you have to remove yourself from those and take a very math-based approach. 

So, when you do sell a security and harvest that loss, you need to find a placeholder security long enough to avoid the wash sale, that will have the same or similar return characteristics over that 31-day period. Then you can sell that and replace it with whatever your desired investment is. 

Analysis of “When I sell Nvidia, what do I replace it with for the placeholder period?”—that is really technical analysis and often beyond the scope of what a lot of even investment professionals can provide. That’s why there are a lot of tax loss harvesters, and they’ll be happy to walk you through what their process is, how they identify replacement securities, how they know how long to hold them. 

Also, too, what is the effective level of loss? That’s the other thing. Not just “when it goes negative.” If the stock’s going to turn around and rally, sure—but maybe that $1,000 or $100 loss would be five or ten, and that might be more effective. 

So really, there’s a lot of consideration—within portfolios, within the construction of portfolios, within the methodology that you’re using to approach tax loss harvesting. So, it’s a generally easy concept that becomes very difficult in practice. 

Cassidy Clement 

Yeah, I mean there’s totally an element of specificity or circumstance that goes into it. Because, as you mentioned, depending on what your goal is, or what the level of loss you were looking for, or turnaround that you’re expecting—all of these elements come together where you have to work with a roadmap of what these potential outcomes could be, and what’s the most advantageous. 

But with all of these layers of complexity and details, if someone were to do this—whether it’s with a professional or consider it on their own—what are some things to keep in mind when they’re incorporating this strategy into their financial goals? Or maybe if they’re just listing it on a wishlist of something they want to learn more about, what are some things to keep in mind? 

The wash sale rule was mentioned several times in our conversation today. If anybody is curious about that, I would definitely check it out in our glossary on the IBKR Campus. But that’s a common one. 

Harry Figgie 

Yep. So first is to understand the IRS guidelines on investment losses—so whether that be wash sale, what losses can offset what kinds of gains, your taxes, how to utilize wash loss carryforwards. It starts with understanding the tax rules, because that will determine how it changes your tax picture and thus your tax alpha. 

I say “tax alpha.” Alpha, simplistically, is the returns by an investment decision. So if you decide to realize a loss and engage in tax loss harvesting—is that really going to mean excess returns? And how do you measure that if you don’t know the guidelines under the tax rules? 

Then the next part is—again, the important part—and that is understanding what you’re selling, understanding what the replacement is, and trying to remove, to the extent possible, investor psychology from the equation, right? 

You need a dispassionate, systematic approach, effectively over a long period of time. Take a loss on a stock that you know really well, replace it, sit in cash and generate the loss… There’s a difference between long-term tax loss harvesting as a strategy and harvesting a loss. 

That nuance—if I didn’t make that nuance clear—let me know, and I can define that a little better. 

Cassidy Clement 

Yeah, there’s definitely the nuance of: what exactly would you like the outcome to be from this loss? And then: what’s actually applicable to you, your situation, and your portfolio? 

When you are working with people or portfolios, is there any mention of any type of cost basis method? I know this is a little more of an intermediate topic—we don’t have to go too deep into it—but I’m just curious. Because some people may look at their cost basis and say, “Okay, this is a whole other rabbit hole.” Is that an element that is taken into consideration often when you’re looking into tax loss harvesting, or is that something that is more just the simple: “Okay, what did you pay? How are we going to incorporate this if there’s any sale going on—LIFO, FIFO, etc.?” 

Harry Figgie 

Yeah, absolutely. Another point for IBKR as a custodian—tax tools. The lot matching tax tools become very important. Especially—I think a lot of people, even your more novice investors—the power of dollar cost averaging, or maybe just doing it accidentally by, “Alright, I have some extra money in my paycheck, let me put that into my account, I’ll buy whatever I’m buying,” and you do that sort of over a long period of time—it’s kind of dollar cost averaging. 

So, when you bought the security, for what price, and at what tax lot—that becomes very important. And if you have the tools, like you do with Interactive Brokers, to select a methodology—whether it’s Last-In First-Out, Highest Cost, Lowest Cost, Maximizing Long-Term Gain—there’s a number of different strategies. Or just identifying and selling a harvesting strategy. 

Cassidy Clement 

I’m glad I mentioned it then. And it’s great that you mentioned dollar cost averaging, ’cause that’s actually one of our other recordings coming up in the next few weeks. It seems like it’s the season of talking about how to really think about how you’re investing. “Riding the wave” was a big thing for a while, and now we’re looking for a more grounded approach of explaining some of these foundational topics. 

And our tax loss tools at IB—for the most part, from what I know—they’re free, like our tax loss harvesting tool. And you can find all of those on our website. 

But you’ve brought some great anecdotes and some great points today. Thanks for joining us, Harry. 

Harry Figgie 

Yeah, of course. 

Cassidy Clement 

So as always, listeners can learn more about an array of financial topics for free at interactivebrokers.com/campus. Feel free to leave us a rating, a review, and follow us on your favorite podcast network. Thanks for listening, everyone.