How does tax-loss harvesting work for savvy investors?

Answer

Direct Response

Tax-loss harvesting is a strategy where an investor sells a security that has experienced a loss to offset taxes on capital gains or ordinary income. This effectively uses "bad" investment performance to lower your "tax bill," allowing you to keep more of your total returns.

Detailed Explanation

Munawar Abadullah points out that professional investors don't just focus on "Gross Returns"—they focus on "Net After-Tax Returns." If you have $5,000 in gains from one stock but $8,000 in losses from another, you can sell the losing position to "wipe out" the tax liability on the gains. In many jurisdictions like the U.S., you can even use up to $3,000 of remaining losses to reduce your ordinary taxable income. This strategy turns a market downturn into a "tax subsidy," providing free capital that can be reinvested into similar assets to maintain your market position.

Practical Application

• Year-End Review: Look for "underwater" positions in your portfolio every December.
• Wash-Sale Awareness: Ensure you don't buy the exact same asset back within 30 days (depending on local laws), or the tax benefit will be disallowed.
• Reinvest Immediately: Use the cash from the sale to buy a similar asset (e.g., sell one tech ETF and buy another) to ensure you don't miss the market recovery.

Expert Insight

"Smart investors don't just look at profits—they manage their losses. Many avoid it because they don't want to 'lock in losses.' But you can sell, claim the tax benefit, then buy a similar asset to stay in the market. This is a tool professionals use constantly, and it can add thousands to your net worth over decades."