The original article was published in the Journal of Beta Investment Strategies.

Tax-loss harvesting (TLH) has been shown to improve the post-tax returns of an investment portfolio.1 Of course, the assets in the portfolio help determine the potential benefit of TLH. In particular, portfolios that follow direct-indexing strategies and hold many individual stocks are likely to yield additional harvesting opportunities as compared to portfolios that hold Exchange-Traded Funds (ETFs).2 Although more complex in its implementation, direct indexing offers the opportunity to leverage idiosyncratic stock-level price movements to enhance expected harvesting yield.

In this paper, we compare the performance of tax-loss harvesting when applied to a portfolio of individual stocks against a portfolio of ETFs. We also calibrate a model that may be used to predict tax-loss harvesting yield conditional on the path of market returns.

Finally, we explore four case studies to demonstrate our TLH predictive model to show the simulated difference between individual stock and ETF harvesting performance across examples of different market environments.

We ultimately conclude that, compared to harvesting ETFS, harvesting a portfolio of individual stocks would be expected to achieve over 3x the harvesting yield over a 20-year period.

Read the full article here.

– Roni Israelov

© [2023] PMR. All rights reserved.

Footnotes

  1. See, e.g., Shalett et al. (2021), Chaudhuri et al. (2019), Berkin and Ye (2003), Arnott et al. (2001), Stein and Narasimhan (1999) and Garland (1987), among others. ↩

  2. We focus our attention on exchange-traded funds rather than mutual funds because ETFs are generally more tax-efficient since they can typically defer realized capital gains until their investors liquidate their positions. Mutual fund investors, on the other hand, must pay taxes each year on capital gains that are distributed at the end of the year. ↩