AFTER A TURBULENT few months for stock prices and with 2015 winding down, talk will soon turn to tax-loss harvesting. The notion: You sell losing stocks in your taxable account, and then use the realized capital losses to offset realized capital gains and up to $3,000 in ordinary income, thus trimming your 2015 tax bill.
Sound like a smart strategy? If you trade individual stocks actively or you’re a really bad investor, tax-loss harvesting might make sense. What about the rest of us, who sit quietly with a handful of mutual funds and exchange-traded index funds, and perhaps also own a few long-term individual stock holdings? Most of the time, there won’t be any losses to harvest.
Yes, if you’re a long-term investor, you might get the chance to realize losses in the first few years that you own a fund or an individual stock. But soon enough, your investments will likely be above your cost basis, and the chance to benefit from tax losses is probably gone forever. Instead, you’ll face an entirely different problem: How do you rebalance your holdings without getting whacked with big capital-gains tax bills?
The upshot: If you’re a sensible investor, I wouldn’t spend too much time worrying about tax losses, and instead focus your efforts on two far more important tax-minimization strategies. First, make sure you keep tax-inefficient investments in your retirement account. That list would include taxable bonds, actively managed mutual funds, stocks you plan to trade and real estate investment trusts.
Second, aim to hold tax-efficient investments in your taxable account, including stock index funds, tax-managed stock funds and individual company stocks you plan to hold for the long haul. These investments might generate dividends each year, but you shouldn’t pay much in capital-gains taxes, unless you opt to sell. You might also hold tax-free municipal bonds in your taxable account, though—as I’ve argued elsewhere—you’ll probably fare better by favoring taxable bonds in your retirement account, while reserving your taxable account for tax-efficient stock holdings.