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 Friday, November 11.
It may be an understatement to say it’s been a rough year for financial markets. Even considering some recent gains, markets have been battered by forces ranging from anxiety around inflation to worries about a recession, alongside one of the most aggressive monetary-tightening programs in modern history. Year-to-date, the S&P 500 Index is down about 16%; the Nasdaq is faring even worse, down about 29%; and the Bloomberg US Aggregate Bond Index is off by 14%.
These losses are painful, but we can try to make use of them. And this is where being tax-efficient can help. Remember that taxes can impose a meaningful drag on returns. To offset this impact, we encourage investors to consider tax-loss harvesting. This is a strategy that can help improve realized returns without adding substantially more risk to a portfolio.
So, what does tax-loss harvesting entail?
Generally, it involves selling positions that are losing money, and using those losses to offset some, or all, of your taxable gains. If your losses are greater than your gains, the harvested losses can also be used against ordinary income, for up to $3,000. Anything left over can be carried forward to reduce your tax liability in future years.
Tax-loss harvesting isn’t just for equities. Currently we’re actually seeing a rare opportunity to harvest losses across fixed income. Since inception in 1976, and prior to this year, the Bloomberg US Aggregate Index has seen only four years of negative total returns: in 1994, 1999, 2013 and 2021. It may make sense to harvest some losses in your bond allocations to offset future tax liabilities.
Whether in stocks or bonds, harvesting can be a good time to reassess your portfolio. If you’d like to maintain your allocation to specific sectors or asset classes, you can use the proceeds from the sales to swap into similar securities or investment vehicles. 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 more favorable opportunity. Think of it as a way to upgrade your portfolio, while using realized losses to your advantage.
Looking ahead, the investing landscape is likely to remain in flux. The Federal Reserve continues to tighten policy into an environment of slowing economic growth, and prospects are weakening for corporate earnings. Against this backdrop, it becomes all the more important for investors to have an “after-tax” perspective on their portfolios. And this is not just something to consider at the end of the year. We encourage investors to engage in active tax-related conversations with their Financial Advisors throughout the year.
Let me close with the reminder that taxes can erode a significant portion of your investment returns, especially over the long term, as they impede the power of compounding returns. But, on the flip side, tax reductions, even if small, can add up over time and make a significant impact on overall wealth accumulation. In fact, our analysis indicates that 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.
Navigating tax implications may not be easy, but Morgan Stanley Wealth Management offers several resources to help. Our GIMA 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. If you have any questions or would like to discuss harvesting losses from your own portfolio, please contact a Morgan Stanley Financial Advisor. Thank you for listening today.
Visit Wealth Management Portfolio Insights for more market commentary and insights from Michael and his team at Morgan Stanley. Find more audiocasts
Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance. Please refer to important information, disclosures and qualifications at the end of this material.
Risk Considerations
For index, indicator and survey definitions referenced in this report please visit the following: https://www.morganstanley.com/wealth-investmentsolutions/wmir-definitions
Hypothetical Performance
General: Hypothetical performance should not be considered a guarantee of future performance or a guarantee of achieving overall financial objectives. Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
Hypothetical performance results have inherent limitations. The performance shown here is simulated performance not investment results from an actual portfolio or actual trading. There can be large differences between hypothetical and actual performance results.
Despite the limitations of hypothetical performance, these hypothetical performance results may allow clients and Financial Advisors to obtain a sense of the risk / return trade-off of different asset allocation constructs.
Investing in the market entails the risk of market volatility. The value of all types of securities may increase or decrease over varying time periods.
This analysis does not purport to recommend or implement an investment strategy. Financial forecasts, rates of return, risk, inflation, and other assumptions may be used as the basis for illustrations in this analysis. They should not be considered a guarantee of future performance or a guarantee of achieving overall financial objectives. No analysis has the ability to accurately predict the future, eliminate risk or guarantee investment results. As investment returns, inflation, taxes, and other economic conditions vary from the assumptions used in this analysis, your actual results will vary (perhaps significantly) from those presented in this analysis.
The assumed return rates in this analysis are not reflective of any specific investment and do not include any fees or expenses that may be incurred by investing in specific products. The actual returns of a specific investment may be more or less than the returns used in this analysis. The return assumptions are based on hypothetical rates of return of securities indices, which serve as proxies for the asset classes. Moreover, different forecasts may choose different indices as a proxy for the same asset class, thus influencing the return of the asset class.
Asset Class Risk Considerations
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.
Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio.
Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.
Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk.
The returns on a portfolio consisting primarily of environmental, social, and governance-aware investments (ESG) may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. The companies identified and investment examples are for illustrative purposes only and should not be deemed a recommendation to purchase, hold or sell any securities or investment products. They are intended to demonstrate the approaches taken by managers who focus on ESG criteria in their investment strategy. There can be no guarantee that a client's account will be managed as described herein.
Tax-loss harvesting. IRS rules stipulate that if a security is sold by an investor at a tax loss, the tax loss will not be currently usable if the investor has acquired (or has entered into a contract or option on) the same or substantially identical securities 30 days before or after the sale that generated the loss. This so-called “wash sale” rule is applied with respect to all of the investor’s transactions across all accounts
Any type of continuous or periodic investment plan does not assure a profit and does not protect against loss in declining markets. Since such a plan involves continuous investment in securities regardless of fluctuating price levels of such securities, the investor should consider his financial ability to continue his purchases through periods of low price levels.
Rebalancing does not protect against a loss in declining financial markets. There may be a potential tax implication with a rebalancing strategy. Investors should consult with their tax advisor before implementing such a strategy.
The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.
The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes. Morgan Stanley Wealth Management retains the right to change representative indices at any time.
Disclosures
Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance.
The securities/instruments discussed in this material may not be appropriate for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor.
This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We and our third-party data providers make no representation or warranty with respect to the accuracy or completeness of this material. Past performance is no guarantee of future results.
This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/disclosures/dol.
Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice. Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.
This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC. Morgan Stanley Wealth Management is not acting as a municipal advisor to any municipal entity or obligated person within the meaning of Section 15B of the Securities Exchange Act (the “Municipal Advisor Rule”) and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of the Municipal Advisor Rule.
Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. This material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney LLC.
© 2022 Morgan Stanley Smith Barney LLC. Member SIPC.
CRC#5102077 (11/2022)