Tax-Loss Harvesting: A Practical Example

This content has been reviewed and edited by an Investment Advisor Representative working for Global Predictions, an SEC-registered Investment Advisor.

Have you ever looked at an investment that’s losing value and thought, “What now?” Watching the red numbers pile up can be frustrating. But here’s the good news: those losses can work for you. Tax-loss harvesting isn’t just about reducing your tax bill—it’s a powerful way to fine-tune your portfolio and set it up for future success.

Let’s break it down. Tax-loss harvesting involves selling investments that have lost value to offset gains elsewhere in your portfolio. It’s an effective strategy to reduce your tax liability while freeing up resources to reinvest in assets that align better with your goals. To show you how this works in practice, we’ve created a relatable example.

How Tax-Loss Harvesting Works Step by Step

Let’s dive into a hypothetical example with our fictitious Emily to see how tax-loss harvesting works in action. Like many investors, Emily’s portfolio was a mix of winners and losers this year. With a little planning, she turned her losses into a strategic win.

Step 1: Identifying the Opportunity

Emily’s portfolio included two standout cases:

• The Winner: She sold shares of a tech stock for a $15,000 gain, creating a sizable tax liability.
• The Loser: A retail ETF with an $8,000 unrealized loss, which she’d held onto for too long despite its poor performance.

After reviewing her situation, it was clear that selling the retail ETF could help offset her gains and lower her tax bill.

Pro Tip: Regularly reviewing your portfolio can help you spot underperforming investments and opportunities for strategies like tax-loss harvesting. Interestingly, JP Morgan published a report showing that continuous tax optimization, when done monthly, can boost returns by up to 1.94% annually - you can read the full report here.

Step 2: Locking in the Loss

Emily sold the retail ETF, officially realizing the $8,000 loss for tax purposes.

• Why it mattered: Unrealized losses might look bad on paper, but until you sell, they can’t work in your favor. By acting now, Emily made the loss useful.

Tip from Us: Timing matters, but you don’t need to overthink it. Acting sooner rather than later often leads to better long-term results.

Step 3: Calculating the Savings

Here’s how Emily’s tax scenario improved:

• Before harvesting: Her $15,000 gain meant she owed $3,000 in taxes at a 20% capital gains rate.
• After harvesting: Applying the $8,000 loss reduced her taxable gain to $7,000, cutting her tax bill to $1,400.

Result: Emily saved $1,600 by taking this simple, proactive step.

Did You Know? If your losses exceed gains, you can offset up to $3,000 against other income and carry forward the remainder to future years.

Step 4: Reinvesting Wisely

Selling wasn’t the end of the story. Emily reinvested her proceeds strategically by buying a consumer discretionary ETF:

• Avoiding the Wash Sale Rule: She chose an ETF with different benchmarks and holdings than her retail ETF, ensuring compliance.
• Maintaining Sector Exposure: Emily stayed invested in a sector she believed in while slightly improving her portfolio’s overall diversification.
• Targeting Better Returns: The new ETF had a stronger track record and better growth prospects (in her eyes), giving her portfolio an upgrade.

Quick Tip: When reinvesting, it’s not just about replacing what you sold—it’s about aligning with your long-term goals.

Step 5: Compounding the Benefits

Emily didn’t just save money on taxes—she laid the groundwork for stronger growth:

• Tax Savings Reinvested: Emily used the $1,600 she saved to invest further, compounding her gains.
• Portfolio Optimization: Selling the underperformer allowed her to focus on assets with better potential.
• Peace of Mind: Emily felt confident knowing her portfolio was now working harder toward her long-term goals. (and she feels a lot less worried about the big red position in her portfolio!)

Lessons from Emily’s Example

Here’s what we believe is most important for you to take away:

1. Tax Savings Add Up: Even small steps like this can lead to significant financial benefits over time.
2. Stay Compliant: Following the Wash Sale Rule keeps your strategy effective and penalty-free.
3. Focus on Growth: Tax-loss harvesting isn’t just about cutting losses—it’s a chance to reinvest for a brighter financial future.

Turning Losses into Opportunities

In our experience, tax-loss harvesting is more than a tax-saving strategy. It’s a way to realign your portfolio, optimize your investments, and set yourself up for long-term success. With the right approach and circumstances, you could save money, improve your portfolio, and unlock the potential to save thousands of dollars over time.

You can use tools like PortfolioPilot.com to complete this entire process in less than 10 minutes. To learn how, click here to read the full article.

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