Is Tax-Loss Harvesting Worth It? Greater After-Tax Returns Through Active Selection

November 2003
Journal of Financial Planning;Nov2003, Vol. 16 Issue 11, p74
Academic Journal
The article describes the powerful combination of active management and tax efficiency through tax-aware active management. Despite slowing equity markets and a more favorable tax climate, tax-aware investing is still the foundation of a successful portfolio for tax-sensitive individual investors. By combining a reliable stock selection signal with a disciplined portfolio optimization process that maximizes tracking error, it has become apparent that it is possible to consistently add value over an index on an after-tax basis. Research indicates that while tax-efficient indexing or loss harvesting, can add value to a taxable portfolio, it has its limitations, even when used in conjunction with stock selection. In simulations comparing all three strategies, we find that tax-aware active management would have outperformed tax-efficient indexing. The level of after-tax outperformance increased significantly post-liquidation when taxes were applied to the previously unrealized capital gains. The inputs to the dividend discount model are the results of bottom-up proprietary equity research by a team of experienced analysts. The point of the study is not to advocate use of a dividend discount model as a stock selection tool, but rather to suggest another way in which investors can use their own stock selection methodology.


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