While no investor wants to take a loss on the stocks, bonds, and other securities they purchase, there may come a time when selling assets at a loss can be a strategic move that yields positive results. Today we’re looking at a strategy known as Tax Loss Harvesting, how it works, and one of the most common methods of reallocating the proceeds from those sales in order to remain on track with investment goals that you may have set.
What Is Tax Loss Harvesting?
First of all, what is tax-loss harvesting?
Tax loss harvesting is a [perfectly legal] tax strategy and investment strategy used to offset realized gains that would increase a tax bill by selling off stocks, bonds, and other investments in order to offset realized gains elsewhere in their portfolio. The proceeds from this sale, which were considered a loss, are then reinvested so that the investor can maintain a similar risk/return profile. While your tax bill should not be the sole reason for making investment decisions, tax harvesting is a useful strategy for offsetting high capital gains taxes while allowing you to stay on track to reaching your financial and investment goals.
What Is a Mutual Fund?
A mutual fund is a type of investment fund where many investors pool their money together to invest in securities like stocks and bonds. These mutual funds are operated by professional managers and they operate consistently with the parameters set in the prospectus that was established when the fund was created. This means that the fund’s manager makes decisions based on an agreed-upon plan that was established at the creation of the fund.
How Can Mutual Funds Be Used for Tax Loss Harvesting?
So how does a mutual fund, like a common S&P 500 index fund fit into Tax Loss Harvesting?
Well, generally an investor will sell off individual stock at a loss which will offset some of their other gains. This keeps their tax bill lower than it would have been if they only reported realized gains. From there, they can invest in a mutual fund or exchange-traded fund (ETF) that gives them access to the same asset class as the asset that was sold off without violating any laws that would prohibit the sale and repurchase of these assets. This workaround allows investors to maintain their hold on some of these investments while helping them offset their realized gains.