Tax-loss harvesting is one of the more underutilized strategies for taxable investment accounts. This approach involves selling holdings at a loss in the current calendar year to offset capital gains and income. Furthermore, there is the opportunity to replace a mutual fund or ETF with a similar investment to maintain a like-kind asset allocation. The net effect is to mitigate the impact of taxes in a particularly bountiful year.
The first step in this process is identifying holdings that are sitting at a loss and may be ripe for a transition. Your monthly brokerage statement or online portfolio view should allow you to easily spot these culprits. The following categories may be the most easily exploited tax-loss harvesting opportunities for 2017.
Despite a second-half rebound, the energy sector has been firmly mired in the red and many investors are still upside down in stocks or funds related to this group. The Energy Select Sector SPDR (XLE) is down over -7% this year and is among the worst major market sectors within the S&P 500 Index.
It’s also worth noting that sub-sectors of the energy space such as the VanEck Oil Services ETF (OIH) and the Alerian MLP ETF (AMLP) have experienced even deeper and prolonged losses over the last several years. These funds and their related holdings may be perfect candidates for tax-loss sellers if they have weighed on an otherwise healthy portfolio.
Those who still believe in the potential value potential or rebound effects of the oil and gas sector may opt to simply rotate their exposure to a similar sector-focused ETF. There is also the option of choosing a more diversified fund with an overweight position in energy such as the iShares Core High Dividend ETF (HDV).
Another struggling sector for 2017 has been telecommunications stocks. The Vanguard Telecommunication Services ETF (VOX) has over $1.3 billion dedicated to a cadre of 27 large-cap companies in this space. Top holdings include Verizon Communications (VZ) and AT&T Inc (T), which have both struggled to maintain relevance in a world dominated by high-growth technology peers.
VOX has fallen nearly -10% this year and continues to demonstrate signs of a more determined down-trend. This ETF and others like it are often found in income-focused portfolios due to their above-average yields and more conservative business attributes.
If you have been stubbornly betting on a return of volatility this year, it’s likely that you are sitting underwater on a few positions. The iPath S&P 500 VIX Short-Term Futures ETN (VXX) and ProShares VIX Short-Term Futures ETF (VIXY) have both fallen nearly -70% through 2017 as the CBOE VIX Volatility Index has remained persistently low. These funds are generally the realm of short-term traders, but have become increasingly utilized by more main stream investors for hedges in recent years despite their structural issues and above-average costs.
Trimming some volatility funds prior to year-end may allow you to off-set a portion of your capital gains in other areas to enhance the tax efficiency of your investment accounts.
The Bottom Line
Tax loss harvesting doesn’t have to be an all-or-nothing strategy. It may simply be an opportunity to re-evaluate existing holdings to determine if they are still meeting your investment criteria and is most effective for those investors in the highest tax brackets. The application of this method may help alleviate a portion of your tax burden and create available cash to utilize in fresh opportunities.
Keep in mind that this process does not apply to traditional retirement accounts, which are not impacted by capital gains or losses.