How Beneficial Is Tax-Loss Harvesting Using Portfolios of Individual Securities?

Osborn, Earl D.
February 2006
Journal of Financial Planning;Feb2006, Vol. 19 Issue 2, p78
Academic Journal
• Tax-loss harvesting using a portfolio of individual securities, such as through a separately managed account (SMA), is increasingly popular On a pre-cost basis, it can appear very beneficial. But this study shows that several factors can significantly reduce the perceived benefit • First it's important to understand that tax-loss harvesting in most cases only defers taxation, unless the taxpayer dies and there is a step-up in basis, or the taxpayer realizes a short-term loss but ultimately a long-term gain. • The author estimates the potential value of this tax deferral by running Monte Carlo simulations and assuming, among other things, that short-term losses are offset against short-term gains. Tax savings are invested in a safe-rate fund equal to the return of three-month Treasury bills. Adjustments are also made for different correlation scenarios. • Under the conditions outlined in the paper the tax benefits of tax-loss harvesting of a portfolio of individual securities is 0.99 percent in annual after-tax return. But this is before costs. Costs that reduce the tax benefits include transaction costs and higher management fees generally associated with SMAs versus an index mutual fund. • Changes in certain circumstances can influence, positively or negatively the benefits of tax-loss harvesting. The benefits decline, for example, (1) the lower the volatility, (2) the lower the ordinary tax rates, (3) the more that losses offset long-term rather than short-term gains, (4) the lower the future stock returns, or (5) the greater that the percentage of return is based on price appreciation versus dividends. INSET: Executive Summary.


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