The very straight forward practice of realizing losses and deferring gains (known as tax loss harvesting) locks in a modest yet real $3,000 annual reduction in taxable income and meaningful tax loss carry-forwards to offset future gains. At death, the cost basis of all assets step up thus avoiding many of those locked in gains entirely. Even when the gain is eventually recognized in the future, the delay works like a loan from the government allowing for more assets working on your behalf. In theory, studies have shown these benefits to tax loss harvesting can contribute 1.25% added after-tax returns a year. Parametric, an investment firm with a similar tax harvesting philosophy, showed in the following graph that during periods of market volatility such as the last 10 years, the contribution can be as much as 1.8%. Other research argues that adjusting for the deduction limitations, the benefit is only 0.51%. Regardless, tax-loss harvesting adds value.
Unlike many others, when appropriate, our approach employs tax loss harvesting across a diverse basket of stocks. Instead of weighting each stock by its market value, though, we start closer to an equal weight across all stocks. This way, given the natural dispersion of stock returns, we can accrue a far larger set of tax loss harvesting opportunities across an array of market conditions. We monitor the positions and wait until the loss exceeds at least $1,500 to limit trading costs. As explained in the section on diversity, employing a basket of stocks also allows us to maximize the benefits of true diversity, including diversity away from risks correlated to an investor’s income or legacy assets. When the stock market is broadly down, however, an index approach can be more effective. To repeat, this version of our approach of owning the basket of stocks versus a fund is only appropriate for some.