Monthly Archives: November 2018

Tax Loss Harvesting: How to Benefit From Your Investment Losses

Published: November 16, 2018

 

Positive investment performance is desirable, but not achievable 100% of the time.Though it may seem counterintuitive, the upside to negative performance in an investment is the potential tax savings when the investment is sold or distributed. 

There are times, during both good and bad market years, when seeking to generate losses through the sale of underperforming investments may present an opportunity.

 

Reaping the Benefits of Losses with Tax Loss Harvesting

The U.S. federal tax system allows for taking realized capital losses on investments against income, which reduces a taxpayer’s overall income tax liability. The process of tax loss harvesting involves proactively selling investments in taxable, non-retirement accounts where the current market values are below the purchase cost bases. This enables the investor to realize losses, which can then be used to offset realized gains as well as additional income.

 

How Can You Apply Tax Loss Harvesting to Your Financial Situation?

Tax loss harvesting can be effected with stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Beyond offsetting capital gains…

 

–> Any net losses (losses that exceed gains) can be used to offset $3,000 in ordinary income.

–> Net losses on marketable investments can also offset gains on the sale of assets, which are taxed at higher long-term rates like gold coins or a gold ETF (at 28%), or depreciation recapture on rental property (at 25%).

–> Any net losses not used to offset gains or ordinary income in one year may be carried forward indefinitely to offset realized gains in other years.

–> Depending on portfolio investments and selling strategy, long-term losses could be used to offset short-term gains which are taxed at ordinary income tax rates.

 

Also, you can sell an asset class- like internationals– and immediately buy the asset class back with a different fund. This strategy allows you to maintain the same allocation to an asset class with a slightly different fund, while reaping the tax benefit. 

 

 

Let’s walk through an example to demonstrate how tax loss harvesting works…

 

Mary owns two investments- BLUE stock and RED stock. BLUE has a $100,000 accrued gain in the investment and RED has a $50,000 loss from its cost basis. Mary is in a tax bracket such that if she sold BLUE stock she would pay 23.8% tax (20% capital gain plus 3.8% net investment tax) on her gain, generating a tax liability of $23,800.

 

$100,000 BLUE Gain @ 23.8% = $23,800

However, if Mary sold both her BLUE and RED investments, she would reduce her taxable gain to $50,000 and her tax liability to $11,900.

$100,000 BLUE gain (minus) $50,000 RED loss @ 23.8% = $11,900

 

tax loss harvesting

 

Why Would Mary Want to Take a Tax Loss on Her Underperforming RED Stock?

Taking the loss on RED could be a choice that is investment strategic. Perhaps, a determination that RED stock was not going to render positive performance in the foreseeable future supports a conclusion that it would be a good time for Mary to sell RED. Or, perhaps, Mary has several lots in RED stock, some of which are at a gain, but she decided to sell her highest purchase cost basis lot because it proffers the best opportunity to take a loss which she can use for reducing her tax liability on her BLUE gain. This approach would exemplify a HIFO (highest-in-first-out) strategy.

 

Why is 2018 a Particularly Good Time to Pursue a Tax Loss Harvesting Strategy?

Even though tax loss harvesting presents a tax savings opportunity in both good and bad market years, the 2018 market volatility may enable investors to lock in greater gains and net those gains with losses to minimize their tax liability. The type of volatility we are experiencing creates considerable divergence – of different international markets, of different industry sectors, and of different asset types, and fielding a net of gains and losses in this environment can be the most effective when compared to less volatile market environments.

 

This divergence can also create a need for rebalancing an investment portfolio necessitating transactions to bring the portfolio into parity with its objectives. Prospective performance can also drive the need for trading. For example, interest rates and their effect on medium-term and long-term fixed income investments may prompt a transfer to shorter-term investments. In short, the opportunity to generate a loss for tax purposes may be attractive outcome coupled with a need to properly maintain the portfolio.

 

What are the Risks Associated With Tax Loss Harvesting?

One considerable risk when harvesting losses is the wash sale rule. The IRS prohibits the recognition of a loss for tax purposes if “substantially identical” securities are purchased within 30 days before or after the loss generating transaction.

 

What qualifies as a “substantially identical” security?

 

–> Securities are the same stock 

–> Two different classes of stock issued by the same corporation

–> ETFs offered by different investment firms that track the same index

 

A loss could be excluded, in whole or part, if the wash rules are not followed. Note that inadvertent violation of the rules can occur if a dividend reimbursement election is in place on a particular security and a reinvestment takes place within 30 days of the loss transaction.

 

There are many reasons and potential applications for investors to employ tax loss harvesting. You should seek the counsel of your tax advisor and financial advisor when implementing a loss harvest in order to maximize the benefits of this strategy. Throughout the month of December, we will be implementing tax loss harvesting strategies for our clients and will proactively notify those concerned. If you have any questions, please contact a member of the Willis Johnson & Associates team for more information.

 

Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions.

International Equities and Market Volatility: A Breakdown and What to Expect

During the month of October, the S&P 500 briefly touched a 10% correction before finally somewhat recovering, and has recently been helped by the political outcome of the election.

 

On the other hand, the international asset class year-to-date has continued to lag the S&P 500 noticeably and has been a cause for concern among market participants.

 

When we disaggregate the contributions to international equity returns this year, we see that the biggest detractors have been the contraction of P/E multiples, and currency weakness against the U.S. dollar. Earnings per share growth has been a positive driver for international company stock performance in 2018.

 

So, what does this tell us?

 

This data indicates that the response to internationals has been driven not by the economic fundamentals of these international markets and companies, but by a reaction to the recent trade conflicts and tariffs, whose effective economic impact has not yet materialized. The selling of these international companies has caused the price to contract while earnings have simultaneously been growing, a sign of forced selling.

 

A prime example of what encapsulates the factors at play in this most recent pullback has been the performance of a number of companies in the Chinese technology sector that have maintained strong quarterly earnings growth through the third quarter of 2018, yet have seen their valuations cut by 35% in 2018. There is a strong disconnect between the company’s earnings and economic prospects and their stock price performance, driven not due to any fundamental differences in these companies’ economic position, but of fears regarding uncertain outcomes of these trade wars.

 

Currently, European, Japanese, and emerging market equities are trading below their 25-year historical average P/E ratios, whereas the U.S. is slightly above its historical average P/E ratio. The valuations overseas continue to look more favorable relative to those in the U.S. In volatile times like these, tried and true investing approaches involve staying the course, recognizing good valuations when we see them, and not overreacting during periods of volatility. It may be a couple of months or as long as 18-24 months before valuations from internationals normalize.

 

You may ask, should we wait to invest until everything has worked out? No, because the first positive results usually yield the most significant returns.

 

If you have any questions about this, please reach out to a member of the Willis Johnson & Associates team.

 

Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions.

The Markets (as of market close October 31, 2018)

The Markets (as of market close October 31, 2018)

October truly was a scary month as stocks closed the month well below their end-of-September values.

 

The tech-heavy Nasdaq lost over 9.0% by the end of October, while the small caps of the Russell 2000 fared even worse, losing almost 11.0%. The S&P 500 fell close to 7.0% – its largest monthly decline in over seven years.The Dow dropped 5.0%, and the Global Dow sank over 7.0%. A slide in internet stocks, coupled with investor concerns that global economic growth is slowing, helped amp up volatility during October. Yields on long-term bonds rose as prices fell, with the yield on 10-year Treasuries climbing about 8 basis points on the last day of the month. By the close of trading on October 31, the price of crude oil (WTI) was $64.95 per barrel, down from the September 28 price of $73.53 per barrel.

 

October 2018 Market Review
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

The national average retail regular gasoline price was $2.811 per gallon on October 29, down from the September 24 selling price of $2.844 but $0.356 more than a year ago. The price of gold rose by the end of August, closing at $1,216.80 on the last trading day of the month, up from its price of $1,195.20 at the… Click here to read the full article.

Approaching the 2018 Midterm Elections as a Rational Investor

Americans will head to the polls in less than one week to vote for their preferred candidate in the United States midterm elections. No matter who controls the House or Senate both parties will no doubt spin their stories jockeying for a perceived mandate.  

The question going into Election Day is: “What are the issues at hand and what is a rational investor to do?”

 

 

“It’s the economy, stupid.” – James Carville, strategist for Bill Clinton’s 1992 presidential campaign 

 

 

Unlike the concerns surrounding Bill Clinton’s presidential campaign, the  issues of today may be in fact, non-issues. The headline unemployment rate has reached historic lows, consumer confidence is higher than before the dot-com bubble, interest rates may no longer be “accommodative” but are no worse than neutral, tax reform boosted paychecks, and the stock market is hitting new records. A frustrated electorate can be found voicing their opinions on every twitter feed and news program, but the economic fundamentals do not support a mass recall of our governing party.  

 

President Trump touted his polling numbers throughout his presidential campaign and has since maintained historically low approval ratings while in office according to ABC News’s  FiveThirtyEight running calculation. While unimpressive overall, there has been a remarkable consistency to the data indicating most Americans disapprove of his presidency. Disapproval as a descriptor may be misguided when judging a man and a president with such a uniquely colorful resume. However, the approval or disapproval of President Trump may not fully encapsulate how Americans will vote for House and Senate candidates of the same party. According to the Reuters/Ipsos polling data, President Trump may face disapproval from Americans who disagree with his character or leadership style but are likely to benefit from his positions on tax reform and deregulation.

 

A rational investor should reference recent examples of misinterpreted polling results as a word of caution – the 2016 presidential election, Brexit, and the unexpected success of Germany’s AFD electoral performance. There appears to be a growing disconnect between headline polling numbers and the eventual results. We may witness yet another departure from traditional polling expectations next week.

 

All 435 House seats are up for reelection this November. Pundits, too numerous to count, are predicting the House will swing left lead by Nancy Pelosi as the new majority leader. As of October 31, 2018, ABC News’s FiveThirtyEight estimates an 85.4% chance of Democrats winning control of the House. Further supporting these predictions are the micro-level shifts in demographics and voting districts that tend to favor Democrats this election season. 

 

The Senate is where things get interesting. Twenty-six of the 35 Senate seats up for grabs are held by Democrats, indicating that the odds favor a continuation — or increase– of Republican control of the upper body. 

 

Regardless of Tuesday’s outcome, corporate CEOs will return to work on Wednesday morning, and American consumers will begin their holiday shopping season. A rational investor should maintain a long-term investment horizon while rebalancing portfolios when market volatility skews the target allocation beyond an acceptable tolerance band.  

 

If you have any concerns or questions regarding the the impact of 2018 U.S. midterm elections on market activity, reach out to a member of the Willis Johnson & Associates team to schedule a conversation with one of our financial professionals.

 

Join Vice President Nick Johnson as he dives into an  in-depth review of recent market activity during our Market Update webinar. Click here to browse our upcoming webinar presentations and register today.

 


SOL_3311 (2)Tyler Baker, CFP®

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Tyler Baker is an associate wealth manager at Willis Johnson & Associates.Tyler enjoys guiding individuals and their families through the financial planning process, and he specializes in uncovering new opportunities that work to minimize client expenses, while increasing their savings.

 

Tyler graduated from the University of Georgia with two degrees, a Bachelor of Science in financial planning, and another in housing management and policy. 

 


 

Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions.

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