Less than two months into 2022, it's understandable that advisors aren't thinking about tax-loss harvesting. After all, that's an endeavor usually associated with the fourth quarter.
Despite that association, there aren't specific times when this strategy can and cannot be deployed. In fact, advisors can put tax-loss harvesting to work for clients at any point during the year. While it's early in 2022, some experts says it's a good time to consider some tax-loss harvesting opportunities.
In simple terms, tax-loss harvesting is a considerable value add for clients because they likely fall into one of three groups 1) aren't aware of it in the first place 2) know about it and don't know how to implement it or 3) are wanting to hold onto a losing position and don't realize there are benefits to parting ways with that laggard.
Even better, the concept is easily conveyed to clients. Tax-loss harvesting is the act of selling a losing position to offset some of the capital gains obligations on profits on a winning trade. In an effort to make some lemonade out of lemons, advisors have ample tax-loss opportunities to consider over the near-term.
Fixed Income Offenders
As was the case last year, the specter of rising interest rates is chastening bond investors in the early stages of 2022, creating abundant tax-loss opportunities. The situation is even more relevant when considering the Federal Reserve is likely just weeks away from its first rate hike of 2022 – one some market observers believe could be as high as 50 basis points.
With that in mind, it's not surprising that more than nine in 10 fixed income exchange traded funds are lower year-to-date and that number swells to 100% when evaluating where these ETFs reside today in relation to prior highs, according to Matthew Bartolini of State Street Global Advisors.
“Moreover, most bond ETFs are trading at a steep loss,” he says. “77% are down more than 4% from their one-year high-water mark. Extend the horizon to a three-year lookback, and the number increases to 84%.”
As Bartolini points out, nearly 500 fixed income ETFs currently sport losses in excess of 4%, presenting advisors with a veritable cornucopia of tax-loss harvesting opportunities. Included in that group of opportunities are aggregate bond funds, which are often favorites of advisors owning to low fees, broad-based portfolios and robust liquidity.
“While the depth of losses is significant, certain bond sectors are feeling more pain than others — particularly when the time horizon and thresholds are adjusted,” notes Bartolini. “For instance, over the past year, within the Aggregate sector $71 billion has flowed into funds that are trading at a loss on a one-year lookback — and the average return on those funds is -6%.”
Tax-Loss Mechanics
There are some moving parts to tax-loss harvesting that advisors should be aware of. For example, advisors are well-versed in that many clients are not is the wash rule, which states that if a losing position is being sold for tax purposes, the proceeds cannot be directed to a “substantially identical” security within 30 days.
Fortunately, the IRS doesn't consider ETFs and mutual funds to be identical securities, so if clients are saddled some turkeys among fixed income mutual funds, consider a move to ETFs because not only will a tax benefit be gained, but likely so will the added perk of lower expense ratios.
Once those plumbing issues are hammered out, advisors can discuss with clients the advantages of deploying tax-loss harvesting today.
“Today’s market activity underscores that tax-loss harvesting should be a strategy implemented throughout the year. If you harvest losses only at yearend, investments that were down early in the year could have bounced back into positive territory — resulting in missed opportunities to sell losers and book losses to offset realized gains,” concludes Bartolini.