The Investment Scientist

What I Learned From Tax Loss Harvesting

Posted on: January 6, 2016

tax loss.jpg

In the last two days I have been doing tax loss harvesting for my clients.

According to Google,

Tax loss harvesting is the practice of selling a security that has experienced a loss. By realizing, or “harvesting” a loss, investors are able to offset taxes on both gains and income. The sold security is replaced by a similar one, maintaining the optimal asset allocation and expected returns.

That sounds simple enough, but actually I learned a few things doing tax loss harvest. 1) You can make money and still claim a tax loss. 2) The difference between TTM Yield vs 30 Day SEC Yield and how to use them to select a bond fund.

Take one high net worth client for example, he has about $500k of DWFIX, an international bond fund. I sold that to realize a $31k loss that he can use for tax deductions. But during the three years that the position was in his portfolio, it generated more than $100k in incomes. So he makes money in this position but still gets to claim a tax loss. How nice!

So lesson number one: investment returns come from two sources: incomes and capital gains. Incomes can not be negative, but capital gains can. When they are negative, they are called capital losses. Regardless of incomes, always realize capital losses ASAP.

For a person in the top tax bracket – combined federal and state marginal tax rate of over 50%,. $31k in harvested capital loss is worth more than $15.5k. Not bad for a click of the mouse.

TTM Yield is trailing twelve month distributions to investors from a fund divided by current value of the fund. The distributions could include returns of capital, which makes this measure useless in comparing across funds.

30-Day SEC Yield is the distribution received by the fund from its holdings that include only dividends and interests (in the last 30 days but annualized) divided by its current value. This measure is forward looking, it does not include returns of capital and it allows investors to compare across funds.

Take DWFIX for example, the fund has TTM yield of 6.53% but a 30-Day SEC Yield of only 1.01%. 6.53% is what DWFIX has returned to investors last year that include quite a bit of return of capital. 1.01% is what DWFIX gets from its holdings which is much more representative of the fund’s earning potential.

That’s why I replace DWFIX with VWEAX that has a TTM yield of 5.81% and a 30-Day SEC Yield of 6.35%.

Schedule a Discovery review with me, or get my white paper for free: The Informed Investor: 5 Key Concepts for Financial Success.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

Twitter: @mzhuang

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