What is Tax-Loss Harvesting? | Erik Averill, Brandon Averill | AWM Insights #5
Episode Notes
The last month has been a wild ride in the financial markets. At one point, we were down 34% and then all the sudden we have seen a quick rebound where - as of today (April 7) - the S&P is up 24.7% from its 52 week low that had been set on March 23rd.
As we mentioned last week, what can happen during these times of flux is that people can tend to rely on asking important questions to the wrong people about what to do with their money. We have seen issues where people have put their trust in experience ("I have lived through this before") rather than expertise ("I'm educated, certified, and experienced in this issue").
In today's episode, we highlight another tactic that can prove beneficial for some called Tax-Loss Harvesting. Topics covered include:
The importance of expertise over experience
What is tax-loss harvesting, and what should I know about it?
The two main benefits of tax-loss harvesting
When does tax-loss harvesting matter?
Who should be benefiting from this practice?
Are there times you should not employ this tactic?
Is it helpful to have multiple investment advisors?
Other strategies that can be utilized during this time
+ Read the Transcript
Erik Averill (00:00):
Hey there everyone. Welcome back to another episode of AWM insights. I'm your host, Erik Averill and I am joined by my brother and co founder of AWM Brandon Averill. Brandon, welcome to the podcast. Always great to be here, Brandon. We continue to just experience some wild rides in these markets. Uh, at one point we were down 34% from peak to trough and emotions were high, very scared and all of a sudden we've seen this quick rebound. And as we're recording this episode today, the S and P 500 is a positive 24.7% from its 52 week low that had been set on March 23rd and so now there's this almost feeling of did I miss out on opportunity? And as we have talked about on previous podcasts, what unfortunately happens during these big emotional times, both to the negative side into the positive side, is people start to rely on asking just random people questions and saying, Hey, you know, what do I have experience of going through Oh eight or 2000 or 87 and unfortunately what happens is as people start to put a lot more trust in where you just alive her, how old are you?
Erik Averill (01:21):
Did you deal with this? As opposed to are you actually a certified financial planner? Are you an actual certified private wealth advisor, an actual chartered financial analyst who has the expertise of how we should be navigating these? And a really helpful analogy that we like to share is from the baseball world is we know the truth is, is just experience age doesn't necessarily equal expertise. And the reason we say this right is, you know, just because you played in the big leagues and you're now 60 70 years old, you're no longer in a big league uniform because just being older doesn't equal expertise. In the, the other example we really hit on right now is, um, which really does drive the importance of expertise is in the baseball world. There's a hitting coach who is now known as one of the leading experts using analytics and Craig wall and Brock and Craig wall.
Erik Averill (02:20):
And Brock has been credited with turning around so many of these players careers using analytics and bat path. And the reason I think I use him as an example is Craig never played past college baseball. So here's a guy that all of the best players in baseball are now relying on how to teach their swing. And Craig never even played professional baseball, but they value his expertise and hopefully that this is going to pull into the financial markets as well as going Brandon instead of just, you know, naively believing, Hey somebody needs 40 years of experience. They should be asking questions of expertise. And that's where we really want to on today is what are a few things that we should be doing in addition to just rebalancing and eventually asset location. What is tax loss harvesting? And you know, what do we need to know about it? Well, yeah, no, I think
Brandon Averill (03:14):
great example you use there, Eric, before we jump into tax loss harvesting, I will say what, what shares tax loss harvesting. And what Craig did is he, there was always investing in his education. He has always, uh, investing in the technology. And I think that's really, uh, a leader here into tax loss harvesting, uh, as you'll see. But tax loss harvesting really is just the practice of selling an investment that's experienced, a temporary decline, such as we've seen more recently. And then taking that sold asset and replacing it with a similar one from, uh, uh, expected return characteristics. What this ends up doing is helping you to maintain that risk level that you desire, um, and eventually, uh, realize those same expected returns. Uh, there's really two primary benefits to realizing or quote unquote harvesting these losses. Uh, the first is offsetting taxes on, on realized capital gains in the future. So no doubtedly you're gonna want to live off your portfolio most likely in the, in the future. And so you're going to have to sell and realize some gains. We can use these losses to offset the tax impact later on. And the second is to actually reduce your tax liability right now on your ordinary income by up to $3,000 per year. So there's a couple of pretty big impacts to this.
Erik Averill (04:33):
So in layman's terms, what I'm hearing you tell me is tax loss harvesting is a way that I can actually pay a lower amount of taxes both today and most likely in the future off of my investment gains. So no, I haven't met a person yet who's like super pumped on paying taxes. So if this is such a good tool, why are most people not talking about tax loss harvesting?
Brandon Averill (04:57):
I mean, that's a great question, Eric. I, it really comes down to tax loss. Harvesting only really matters and it trust me really does matter for those people that have, uh, maximized all their tax deferred savings and IRAs or 401ks and they have at least one taxable account. Unfortunately, we know that this is also the minority of people. Uh, the stats don't lie that, you know, 0.7% of singles and only 0.9% of married people are actually in that highest tax bracket. So what this ultimately means is that there's very few financial groups that focus on this type of, uh, this type of client, the client that's in that highest tax bracket. Most of the advisory firms out there, certainly the wirehouses, the big broker models are built to work with a massive fluent, and so they're just not used to having to deal with complex tax tax issues and implementing things as tax loss harvesting.
Erik Averill (05:58):
Yeah, I think that's a great point. Right? And it, it's not a knock to say that Hey, if you're not in the top 1%, there's, there's something independently wrong from you and you absolutely need a ton of advisors to help the 99% of, of the population. Um, and using a certified financial planner that, that focuses on, that demographic is fantastic. But like you're saying is there's just, there's 40% of every dollar at risk for those in the highest tax bracket. And so making sure you have an advisor that that's integrated and you know, you can easily check on your advisor to see if they actually can do even tax planning. A lot of times you just go to their company website. And if you look at the very bottom and the disclosures, a lot of the big brokerage houses, it blatantly says we do not provide tax advice, which should be a huge red flag. Um, Brandon, can you, can you dive in a little bit more of like, okay, you've explained why people don't talk about it, but can you talk about some of the big benefits and who who should be benefiting from tax loss harvesting?
Brandon Averill (07:03):
Yeah, absolutely. So there, there's a couple, I guess, criteria that should initially qualify you. Um, number one, are you investing in a taxable investment account? If the answer is yes, then tax loss harvesting probably as something they should take a look at. Uh, another example is generational wealth. So if you've been able to save or you have, uh, the guaranteed future income where you're going to save enough money, that it's going to support you, your family, uh, for the rest of your lives, and you're looking at passing money on to the next generation or donating to charity, a tax loss harvesting certainly is something that you should be implementing. Um, but it's also not a full proof method as much as we look at the times that you should be doing tax loss harvesting. There's also some times where you shouldn't and it could be harmful.
Brandon Averill (07:51):
One of the examples of this is your future tax bracket is going to be higher than your current tax bracket. If you think that's going to be the case, then you probably shouldn't be doing tax loss harvesting. Another example is, uh, if you can currently realize, uh, your capital gains rated a 0% tax rate under current law. This is if you're single under 40,000 roughly of income or if you're married roughly under 79,000 of income. A good example of this is actually something we implement with many of our clients. Uh, that are playing in the minor leagues. They've realized high income when they were drafted and they got a big signing bonus, but then their income dropped pretty significantly. So we actually flip this on our head on its head and we try to realize income, uh, realized capital gains during, during that period because their income's low and we can actually do so at a 0% tax rate.
Brandon Averill (08:47):
And then I would say the third thing is, uh, something called wash sale rules. So there's all kinds of, there's some rules to actually be able to realize gains. And this is somewhere, uh, that we see unfortunately gets lost. Uh, there's a, there's a belief out there that having multiple investment advisors is a good way to get diversification to set up your portfolio. Uh, and what we see as unfortunately, um, that's just kind of a, a false security. Um, and it almost becomes impossible to do tax loss harvesting because you can't keep track of what's called wash sale rules. Uh, you have no idea, no transparency in what other investment advisors are holding when you should sell, when they're buying, et cetera. So, you know, you kind of blow up the whole opportunity if you're working with multiple investment advisors.
Erik Averill (09:39):
Brandon, that's, that's super helpful. And I think just, uh, an emphasis of not trying to apply, you know, general advice, uh, to a very specialized expertise that's required. So, you know, just being sensitive to time too, to our listeners, we talked about previously the huge importance of rebalancing. We've now here covered tax loss harvesting of how to truly lower your, your current taxable income and offset future gains so you can take more money into your pocket. Are there any other strategies that our high net worth investors should be taking advantage of during these times?
Brandon Averill (10:22):
Yeah, I mean, I'll relate both these back to tax loss harvesting and really how do you maximize tax loss harvesting? The first thing that you could be doing to help with this is contributing on a regular basis. This goes against all of our gut feelings, um, but we need to continue to contribute, especially through periods of high volatility, uh, because the more times you put money into your investment portfolio, the more opportunities you have for tax loss harvesting. In the future, um, because you're buying at different levels. And then the second would be, uh, uh, something called asset location. This is something we practice at our firm. Um, but again, it kinda goes back to you gotta have those taxable accounts. You gotta have the tax deferred accounts. And what it simply is, is looking at your entire all your accounts as one portfolio. Um, unfortunately, many firms can't look at your, your employer 401k. Uh, fortunately there are technologies and, and independent firms like ourselves out there that do. And when you do this, you end up putting your, uh, the most volatile assets typically are held in your taxable account. So it just gives us more opportunities to harvest losses there if the opportunity arises. Um, and I'm sure Eric will dive into that asset location topic in a future. AWM insights.
Erik Averill (11:41):
Thanks Brandon and listeners. Thank you guys so much for your attention. We know that during these times it can be emotional. Um, and we encourage you to rely on your certified private wealth advisor. This is our expertise. This is our job to help you focus on what you can control, which is being patient, staying focused, and staying longterm. And so until then, have a great week and we will catch up with you next week on another episode of AWS insights.
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