How Tax-Loss Harvesting can help maximize tax efficiency

By Goldman Sachs Personal Financial Management

Taxes: They can’t be avoided. But they can be managed. For example, a tax-loss harvesting strategy may help you keep more of what you earn by helping minimize what you owe in taxes on investments, leaving you with more money to invest to help maximize your return on life. This article explains how tax-loss harvesting works and why we think a customizable separately managed account (SMA) can be an effective way to potentially maximize tax efficiency.1

What is tax-loss harvesting?

Simply put, tax-loss harvesting is a strategy designed to reduce your overall tax bill so you can keep more of what you earn from your investments. It works by selling investments at a loss and using those losses to offset some, or possibly all, of the capital gains from investments that you sold at a profit.

For example, if an investor buys a stock at $400 and sells it for $500, they realize a capital gain of $100. This will trigger a capital gains tax (the amount will depend on variables such as the investor’s marginal tax rate, state and local tax rates and how long they held the stock). However, if the investor sells another security at a $100 loss, they can use that realized loss to offset the gain from the sale of the other stock. As a result, the net realized gain is reduced and the investor’s overall tax bill is lowered.

How you might apply tax-loss harvesting in an equity strategy can vary depending on your objective and risk tolerance. If your objective is increased after-tax returns and you are comfortable with an index-oriented strategy, you may consider a customizable SMA, which allows a manager to reduce your tax bill by “harvesting” losses while maintaining broad market exposure.

Here’s how tax-loss harvesting works:

  1. The SMA holds a diverse group of stocks designed to closely track the returns of a predetermined index, such as the S&P 500.2
  2. The manager opportunistically sells stocks throughout the year that are trading at a loss. This happens when the stock price falls below the price at which it was purchased, also known as the investment’s “cost basis.”
  3. The manager then replaces those stocks with securities that have similar risk and return characteristics.
  4. For example, they may decide to sell the stock of a large financial institution that is trading at a loss and replace it with another stock or set of stocks—perhaps those issued by other large banks. The realized losses are then used to offset capital gains incurred in other parts of the investor’s portfolio.

There are many ways for investors to end up with a tax bill at year-end. Examples include investment gains from other active managers, capital gains distributions from mutual funds, selling appreciated real estate, private equity distributions or investing in hedge funds which may not be tax efficient.

Note the purpose of tax-loss harvesting is not to pick losing stocks. It is simply to help investors benefit from naturally occurring market volatility and dispersion in stock returns. Think about it this way: Even in years when an index such as the S&P 500 delivers a positive return, not every single stock in the index has a positive return throughout the year. Some stocks experience losses throughout the year and may even end the year in the red.

While market returns vary from year to year, market volatility is a constant. Volatility and dispersion of stocks’ returns create potential opportunities to harvest losses, which adds value to an investment portfolio by potentially increasing after-tax returns. Of course, the amount of potential tax savings depends on the market environment— typically, a year with low market returns will provide more harvesting opportunities than a high return year. But we believe tax-loss harvesting can work in any market environment because losses exist in all market environments.

Losses exist in all markets

Tax-loss harvesting seeks to provide value in all market environments.

Source: Goldman Sachs Asset Management, Standard & Poor's. As of December 31, 2020.
There is no guarantee that these objectives will be met. Goldman Sachs does not provide accounting, tax, or legal advice. Please see additional disclosures at the bottom of this page. Past performance does not guarantee future results, which may vary.


Tax efficiency: How tax-managed SMAs differ from ETFs and index funds

Exchange-traded Funds (ETFs) generally have low expenses, and most are passively managed and structured to track an index. But when it comes to tax efficiency, there are three key differences between them and SMAs:

1. An ETF or index fund investor owns shares in a fund that tracks an index. With an ETF, an investor may only harvest a loss when the entire index is down. In contrast, the SMA investor directly owns the individual securities in their portfolio. This is sometimes referred to as “direct indexing”. By owning all of the underlying securities, a manager can harvest losses when the index is down but can also opportunistically sell individual stocks trading at a loss in pursuit of higher tax savings and after-tax returns compared to an ETF.

2. In an ETF or an index fund, all realized losses within the fund can only be used to offset realized gains within the fund, whereas realized losses in a SMA can be used to offset gains anywhere else in an investor’s portfolio. This can potentially add up to greater tax savings. (For more on ETFs see disclosures.)

3. SMAs can generally be funded with both cash and in-kind stock contributions. Existing stock positions in an investor’s portfolio can be transitioned in-kind into an SMA and managed with greater tax efficiency.

Long-term potential benefits of tax-loss harvesting for an investment portfolio

When repeated in a systematic way, year in and year out, tax-loss harvesting can reduce your tax bill. That means an investor is not only saving money on their taxes in a given year, but they can reinvest those tax savings for potential growth in the future. And the longer a portfolio stays invested, the more time it has to grow and compound.

Who may potentially benefit from tax-loss harvesting

All taxable investors may potentially benefit from tax-loss harvesting strategies; investors in the highest tax brackets stand to potentially benefit the most because the higher the tax bracket, the bigger the potential savings.

It also helps to have capital gains from other parts of an investor’s portfolio. This could include gains from selling down concentrated stock, private equity or other active managers. If an investor doesn’t have capital gains from other investments in a particular year, harvested losses can be used to offset $3,000 in ordinary income per year. 3 This includes interest, wages, dividends and net income from a business. Any excess losses can be carried forward indefinitely and used to offset capital gains in the future.

Investors who may want to consider tax-loss harvesting include those who plan to donate their portfolio to charity or bequest it to heirs, as this would not involve realizing capital gains. Investors who plan to liquidate their portfolio eventually would then pay taxes on realized gains. But if they employed tax-loss harvesting over a long investment horizon, they may find that the portfolio appreciated more than it would have had it been invested in an index strategy without tax management.

Access Goldman Sachs’ proprietary tax-loss harvesting strategy

To learn how to incorporate tax-loss harvesting into your investing strategy, connect with a PFM personal financial advisor. As a PFM client, you have access to the best thinking of Goldman Sachs Consumer & Wealth Management’s Investment Strategies Group, access to tax-efficient personalized portfolios as well as the firm’s other vast resources. Working as a partner in your corner, your advisor can help you create and adapt your financial strategy to help minimize financial stress and maximize your return on life, today and tomorrow.

1 Goldman Sachs PFM does not provide tax advice. Clients should obtain their own independent tax advice based on their particular circumstances. GS PFM makes recommendations based on the specific needs and circumstances of each client. All services are subject to suitability and availability.

2 Diversification does not protect an investor from market risk and does not ensure a profit.

3 See Capital Losses: https://www.irs.gov/pub/irs-pd...

Glossary

Separately Managed Account (SMA): A portfolio of individual securities managed on an investor’s behalf by a professional asset management firm. Because the investor owns the underlying securities, and SMA provides more control than other investment vehicles and can be customized to fit individual investor needs.

ETF: A type of security that tracks an index, sector, commodity or other asset but can be purchased or sold on an exchange, like an individual stock.

Capital Gains: An increase in an asset's value, which for tax purposes is considered to be realized when the asset is sold. A capital gain may be short-term (one year or less) or long-term (more than one year) and must be claimed on income taxes.

S&P 500: The S&P 500 Index is the Standard & Poor's 500 Composite Stock Prices Index of 500 stocks, an unmanaged index of common stock prices. The index figures do not reflect any deduction for fees, expenses or taxes. An investor cannot invest directly in an unmanaged index.

Dispersion refers to the range of possible returns on a type of investment.

In-Kind Stock Contributions refer to transactions in which an investor moves assets from one brokerage account to another as-is. There's no selling off assets or buying new ones.

Disclosures

United Capital Financial Advisers, LLC d/b/a Goldman Sachs Personal Financial Management (“GS PFM”) is a registered investment adviser and an affiliate of Goldman Sachs & Co. LLC (“GS&Co.”) and subsidiary of The Goldman Sachs Group, Inc., a worldwide, full-service investment banking, broker-dealer, asset management, and financial services organization. Advisory services are offered through United Capital Financial Advisers, LLC and brokerage services are offered through GS& Co., member FINRA/SIPC.

GS PFM makes recommendations based on the specific needs and circumstances of each client. Clients should carefully consider their own investment objectives and never rely on any single chart, graph, or marketing piece to make decisions. Investing involves risk, and investments may lose value. There are no investment strategies that guarantee a profit or protect against loss.

GS PFM does not provide legal, tax, or accounting advice. Clients should obtain their own independent legal, tax, or accounting advice based on their particular circumstances.

Case studies and examples are for illustrative purposes only. The information contained herein is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. The material is based upon information which we consider reliable, but we do not represent that such information is accurate or complete, and it should not be relied upon as such. The information, data, analyses, and opinions contained herein include confidential and proprietary portfolio information of GS PFM, may not be copied or redistributed for noncommercial or personal purpose without GS PFM’s expressed permission.

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In July 2019, Goldman Sachs acquired United Capital Financial Advisers, LLC. Not all services, products, tools and practices described apply or are available to all clients. Products and services obtained by United Capital clients prior to the Goldman Sachs acquisition were subject to different standards of review and diligence. Before agreeing to engage in services with GS PFM, you should consult with your advisor about the particular services, products, tools, and practices that will be applied to your relationship with GS PFM.

All investments contain risk and may lose value. Exchange-Traded Funds are subject to risks similar to those of stocks. Investment returns may fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed, or sold, may be worth more or less than their original cost. ETFs may yield investment results that, before expenses, generally correspond to the price and yield of a particular index. There is no assurance that the price and yield performance of the index can be fully matched.

Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant. There is no guarantee that objectives will be met.

ETFs: Since ordinary brokerage commissions apply for each ETF buy and sell transaction, frequent trading activity may increase the cost of ETFs. While extreme market conditions could result in illiquidity for ETFs, typically, some are more liquid because they trade on exchanges.

Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.

Based on “Tax-Loss Harvesting Strategies: How They Work” by “Goldman Sachs Asset Management (“GSAM”)”, © 2021 Goldman Sachs.

Additional materials and revisions by © 2022 United Capital Financial Advisers, LLC d/b/a Goldman Sachs Personal Financial Management. All Rights Reserved.

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ABOUT THE AUTHOR

Goldman Sachs Personal Financial Management

United Capital Financial Advisers, LLC d/b/a Goldman Sachs Personal Financial Management (“GS PFM”) is a registered investment adviser and an affiliate of Goldman Sachs & Co. LLC and subsidiary of The Goldman Sachs Group, Inc., a worldwide, full-service investment banking, broker-dealer, asset management, and financial services organization.

The information contained herein is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. GS PFM does not provide legal, tax, or accounting advice. Clients should obtain their own independent legal, tax, or accounting advice based on their particular circumstances. Please contact your financial adviser with questions about your specific needs and circumstances.

Information and opinions expressed by individuals other than GS PFM employees do not necessarily reflect the view of GS PFM. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice.

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