Maximizing Investment Returns with Tax Loss Harvesting

In this video, Matt Blocki explains the concept and advantages of tax loss harvesting for investors with non-qualified brokerage accounts. He illustrates how selling a depreciated asset, like stocks, and then buying similar assets allows investors to realize losses. These losses can offset other capital gains or up to $3,000 of annual income, offering significant tax benefits. Blocki highlights direct indexing as a strategic approach to maximize tax loss harvesting opportunities, contrasting it with traditional index fund investments. By focusing on individual companies within an index, investors can frequently harvest losses, enhancing tax efficiency and potentially reducing future tax liabilities significantly. This strategy is especially beneficial for high-net-worth individuals and retirees looking to optimize their investment tax implications.

Video Transcript

what are the benefits of tax loss harvesting? More importantly, what is tax loss harvesting? So tax loss harvesting is something that you can do in a non qualified brokerage account. So, very simply put, if you have invested, let’s say, a million dollars in a stock, let’s say it’s Pepsi, it drops $900,000. You still believe in the industry. You can sell Pepsi, buy Coca Cola, 30 days go by, you can flip back to Pepsi if you think it’s a better company. But as long as you don’t buy Pepsi within that 30 days, that loss of a million down to 900, that $100,000 you got to carry with you for the rest of your life. So up to $3,000 of that loss on a yearly basis could be taken to offset your income. But up to 100% of that loss can be used to offset other short term or long term. Doesn’t matter. Short term or long term gains in a different stock, or if you’re selling a business or a real estate, long term or short term gain as well. So these are very useful for clients that have diverse portfolios. Having these stock losses that carry forward every year can essentially eliminate or erase a lot of tax liability in the future. And one of the best ways to do this is through what’s called direct indexing. And I’m going to explain here on the screen, the Russell 3000 index. This shows really the data from the last 15 or 2006 through 2021. So the actual data of negative years. So if we pull out 2008, 2018, there were essentially two years that the market went down over these 15 years. And so if you were investing in a fund like the Russell 3000 index, those years especially, maybe you sell out of the Russell 3000 index and you buy some other fund for 30 days before you buy back into it. Also, there typically are major swings that do happen intra year. But for you to get tax loss harvesting in a fund, you need the whole fund to drop below your basis in order to exchange out of it 30 days and back in for you to actually get the benefit of tax loss harvesting. However, if you unwind the Russell 3000 index and actually look at what’s happening every year, but 2008 and 2018 were positive here. However, there were lots of positive stocks in the 3000 and lots of negative stocks. So instead of holding the index, if you instead held the individual companies that comprise the index, or enough of them to have a tracking error very close to the index returns, then you’d have lots of opportunities for tax loss harvesting. So let’s just look at 2021, for example. So if you’ll notice, about 2055 of the companies were positive that year and 992 of the companies were negative that year. But you still got over a 25% return if you stayed invested. So if you were invested in the index fund itself, really there’d be no opportunity for tax loss harvesting that year. Why? Because you need the whole fund to drop. If you held the individual companies, you’d have had 992 chances to tax loss harvest, all while getting a similar or within a 2% threshold of the same return. So why would this beneficial for someone that high net worth that’s going to retire eventually? Well, let’s just look at really simply a scenario of a versus b. So a, let’s say, puts in a million dollars, invest in an index fund and grows to $2 million versus b, puts in a million dollars, does a direct indexing strategy. So holds the stocks all while getting index like returns, all within a small tracking error. Also grows to $2 million over the same time period. So let’s just say this is hypothetically over eight years roll of 72, we need about a 9% compounded growth rate to double the money. So then we go to unwind these holdings. So really simply in scenario a, if he’s done no tax loss harvesting, the million dollars of basis comes back out tax free. A million dollars of this is growth. In Pennsylvania, you would pay a 23.8% federal tax if you’re in the top tax bracket, plus a 3.7% state tax. I’m just going to round up and say it’s 27%. So we would lose $270,000 to taxes. So the net, the 2 million minus the 270, you would keep 1.73 million. However, of the direct indexing along the eight years, with about a third of the companies on average on a year to year basis going down, if we turn those over, all getting the same returns, you go to unwind this $2 million, a million dollars of your basis comes out tax free. The million dollars of gains, hypothetically, get erased by all the diligent tax loss harvesting that you take out. And this is just for an illustration. Hypothetical example. Those losses offset all the gains and now we have all $2 million to your pocket. That’s just a very tangible, high level idea of how tax loss harvesting can benefit you, how it can be really beneficial if you have a big pile of non qualified money, and how you can sometimes use your stock losses to offset a business sale, a real estate transaction, et cetera. So can be really good from a tax liability management perspective. Not only long term, but also along the way,

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