Your last investment move for 2024

In my September blog post titled It's not what you make, it's what you keep I discussed how tax-loss selling should be an actual year-round investment strategy vs a single, year-end trade.

Many investors wait until the end of the calendar year to consider tax-loss harvesting, but the challenge with this approach is that the market often finishes the year with a positive return. (Think Santa Claus rally). In fact, 13 of the past 16 years, the S&P 500 has followed this pattern.

Since writing that blog, the S&P has rallied almost 7%, with some individual stocks up more than twice that! Although this is a good problem to have, the opportunity for booking losses in equities this year continues to diminish.

Beware of the gains you don't see coming

As an avid trail runner, the joke is that it's always the rock you don't see that trips you up. The same can be said about capital gains from mutual funds and ETFs. By law, both investment structures are required to pay out at least 90% of dividends and capital gains to shareholders on an annual basis...regardless if you, the shareholder, has sold or not. This means that investors could be potentially facing capital gains, even if they haven't had the need to liquidate their positions at any time this year.

As these managers may want to hold onto stocks as long as possible, especially during a rally that we are seeing for 2024, many of these distributions will occur as late as possible into December. By the time they've distributed these gains, it may be too late to cover them with losses. Several asset management firms have started to publish estimates for what their respective funds may distribute to shareholders in the form of short and long-term capital gains, so now is the time to get an idea of what to expect from them.

Look for losses beyond equities

From 2022-2023, the Fed increased interest rates 11 times and the result was that many bonds and bond-funds saw negative price returns as interest rates rose. (A bond’s price moves inversely to its yield). While bonds have bounced back in 2024, after three consecutive years of poor performance, this year still presents an opportunity to tax loss harvest any losses, while still taking advantage of historically high fixed income rates.

Whether it's a bond ETF, mutual fund, or individual holding, the price of that fixed income investment is most likely lower than where it was purchased. Conversely, the yield you are receiving has stayed the same. By selling that position, you can lock in the loss, and then reinvest the proceeds in another fixed income investment while locking in todays' (most likely) higher yield. Thus putting more annual income in your pocket, while booking the loss!

Avoid wash sales

After selling a position at a loss, investors have the opportunity to reinvest the proceeds in a similar asset to maintain their portfolio’s asset allocation. In doing so, they must take the “wash sale” rule into consideration. This Internal Revenue Service (IRS) rule mandates that an investor cannot claim a loss on the sale of an investment and then buy a “substantially identical” security within 30 days before or after the sale. The rule prevents people from selling securities at a loss and then immediately buying them back just to get a tax benefit.

Unfortunately, the IRS does not offer a precise definition of what constitutes a substantially identical security. To avoid inadvertently triggering a wash sale when reinvesting proceeds in a similar investment, investors should consider the degree of holdings overlap as well as the degree of difference in prospective returns between the two investments. Common replacements that are generally not considered substantially identical include two mutual funds, closed-end funds, or ETFs tracking the same benchmark but managed by different advisors, or two bonds or stocks within a similar industry. However, exceptions exist so investors should always consult with their tax professional to consider their options.

How tax-loss harvesting can help manage taxes both this year and next

Tax loss harvesting is designed to help defer paying taxes until later, but it is possible that the strategy will help you avoid paying capital gains taxes altogether.

1. The losses can be used to offset investment gains that occurred in the current calendar year...whether it's outright sales or unwanted distributions from mutual funds or ETF's.
2. Remaining losses can offset $3,000 of income on a tax return in one year. (For married individuals filing separately, the deduction is $1,500.)
3. Don't forget that any unused losses can be carried forward indefinitely. I have clients that literally still have losses they are carrying forward from the dotcom tech bust of 2000!

Tax-efficient portfolio construction

When left with constructing a portfolio on their own, often there is little consideration of taxes, so investors may have unachievable or unrealistic return expectations. Conversely, attempting to construct a portfolio simply to minimize taxes can also result in opportunity costs that can leave investors less likely to achieve their goals.

We feel that building a portfolio primarily based on specific life goals - retirement, education, vacation, etc. - makes the most sense and is the most realistic. However, utilizing a proactive tax strategy throughout the year can add alpha to an investment portfolio, while also giving you better control of your tax liability early enough so you're not scrambling come year-end.

-Jason

Any opinions are those of Jason Macaluso and not necessarily those of Raymond James.

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision. Raymond James and its advisors do not offer tax advice. You should discuss any tax matters with the appropriate professional. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise.