An Alternative “ETF” Look at Tax-Loss Harvesting

by:
Chief Investment Officer and Managing Director | IndexIQ

One of the most frequently cited benefits of ETFs is their tax efficiency. So, what does this mean for investors thinking about year-end tax-loss harvesting?

As we have noted in previous postings, ETF tax efficiency takes place at the portfolio level – in-kind trading of securities minimizes or eliminates capital gains, while harvesting valuable capital losses that can be used to offset future capital gains. But, individuals may still have gains, based on their own buying and selling of ETFs. (If you buy an ETF at $10/share and sell it at $11 in a taxable account, you will have a potentially taxable gain.) With markets up strongly to date and investors realizing more capital gains this year than in the past, offsetting losses may be harder to come by.

Traditional loss-harvesting advice has generally revolved around “like for like” trades – selling Pepsi and buying Coke, to cite one frequently used example. This can allow for capturing a tax loss that avoids the “wash-sale rule” – the prohibition against selling and buying back a substantially identical security within 30 days, while leaving overall portfolio exposures in place. But, with markets setting new records – and the Federal Reserve apparently determined to continue raising interest rates – this may be a good year to consider something slightly different – using tax-loss harvesting to fine tune the risk/reward characteristics of a portfolio.

One strategy worth a look may be to add to the alternative holdings in the portfolio. No one knows where stocks go from here, but we do know that we’re in the midst of one of the longest-running bull markets in history. Further, we’re coming out of a year remarkable not just for its returns, but for its nearly unprecedented low volatility. A stock market axiom that has proven its usefulness over time is reversion to the mean. We can comfortably predict that when it comes to volatility and market corrections, we will see mean reversion again. A multi-asset class liquid alternative ETF is different in kind than an ETF that uses equities only to track the S&P 500, and thus, can be a useful tool for diversification.

Losses in individual stocks can be used to offset gains in ETFs as well. This, in turn, could allow for the migration from single-stock exposure to the more diversified portfolios that are generally a feature of ETFs. ETF share lots with negative returns from previous years can be targeted for sale as well, and those losses may be useful in offsetting current gains.

Of course, strong market returns are not a bad problem to have. With the underlying economy continuing to expand and corporate earnings generally showing healthy growth, there are plenty of reasons to be optimistic heading into 2018. But, for investors concerned with today’s market levels – or those who just want to take some profits off the table – it’s worth reviewing the portfolio to see if tax-loss harvesting makes sense.

NOTE: The usual caveat when it comes to taxes: Everyone’s circumstances are different, so working with a knowledgeable tax expert is advisable when considering year-end investment strategies.

About Risk:

All investments are subject to risk and will fluctuate in value. Past performance is not indicative of future results. An investment can’t be made in an index.

The information and opinions contained herein are for general information use only. IndexIQ does not guarantee their accuracy or completeness, nor does IndexIQ assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice. Past performance is no guarantee of future results.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the mutual fund. NYLIFE Distributors LLC is located at 30 Hudson Street Jersey City, New Jersey 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is Member FINRA/SIPC.

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Salvatore J. Bruno

Chief Investment Officer and Managing Director | IndexIQ

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Sal joined IndexIQ in 2007 from Deutsche Asset Management (DeAM) where he held a number of senior positions

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