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  • Jun 1, 2022

Tax-Loss Harvesting May Be an Upside to a Down Market

Speaker: Michael Jabara
Tax-Loss Harvesting May Be an Upside to a Down Market


Michael Jabara: Hello and welcome to another edition of Wealth Management Insights. I’m Michael Jabara, co-head of Global Investment Manager Analysis, also known as GIMA, for Morgan Stanley Wealth Management, and I am recording this on Wednesday, June 1st.

Anxiety around inflation, monetary policy and economic growth is driving a prolonged stretch of market volatility. With turbulence in both stocks and bonds, it seems investors have few places to turn to, and long-term planning around investment goals is increasingly more difficult than it used to be. This means that you will probably need to take advantage of every avenue by which you may be able to improve your portfolio’s average annual gains.

There are several ways to potentially boost your returns, including increasing portfolio risk or incorporating illiquid investments. But today I’m going to talk about taxes, which can be a meaningful drag on investment returns, and how investors could seek to improve investment returns through tax efficiency. In particular, I’ll zero in on tax-loss harvesting, a strategy that may help improve realized returns, without adding substantially more risk or reducing flexibility.

What does tax-loss harvesting entail? This strategy essentially involves “harvesting,” or selling positions with losses in your portfolio, and using those realized losses to offset some or all of your realized or potential future gains. This, in turn, would reduce your tax liability in the next filing season or in future years.

With the proceeds from the sales, you can swap into similar securities or investment vehicles in order to maintain your portfolio’s allocation to specific sectors or asset classes. One important point here is to be careful not to run afoul of what are known as wash-sale rules that govern tax swaps.

You can also use harvesting as an opportunity to move out of securities or investment products with less potential and into investments that may present a favorable opportunity. Think of it as an effort to upgrade your portfolio, while using realized losses to your advantage.

And my last point is why now—why we encourage investors to contemplate tax-loss harvesting in the current environment. Taxes might seem like a once-a-year consideration, but they should really be part of an active, ongoing evaluation of your portfolio and overall financial picture throughout the year. And especially in a time of significant market volatility and sell-offs like the ones we’ve been currently experiencing, this strategy might turn out to be helpful.

Let’s consider the market for a minute. The S&P 500 Index is down about 13% for the year. The Nasdaq is down about 23%. As for sectors, nine out of the 11 S&P 500 sectors are in the red so far in 2022, with Energy and Utilities being the only ones that are up. The investing landscape is likely to remain in flux, with the Federal Reserve continuing to tighten policy into an environment of slowing economic growth, as well as weakening prospects for corporate earnings. With further declines in the stock market expected, tax efficiency may become all the more important for investors to keep more of what they earn.

Let me close with the reminder that taxes can erode a significant portion of your investment returns each year, especially over the long term, as they impede the power of compounding returns. But in a similar way, small tax reductions can add up over time and make a significant impact on overall wealth accumulation. For instance, an improvement of a half a percent a year in after-tax returns can result in a wealth difference of 50% after 30 years of distributions. And again, even though taxes may often be a conversation for the end of the year, there are market losses now, which of course aren’t pleasant, but you can make them work for your portfolio.

Morgan Stanley offers several resources to help navigate this landscape. Our Global Investment Manager Analysis group has a number of tax-efficient investment options across asset classes. And our Tax Management Services team can help you actively manage capital gains throughout the year. To find out more and determine what course of action is appropriate for you, please contact your Morgan Stanley Financial Advisor. Thank you for listening.

Tax-loss harvesting can be an effective way to potentially improve your investment returns. And now may be an apt time to consider this strategy. Listen to learn more.

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