Overcoming Volatility with Tax-loss Harvesting

December 16, 2022

With tax-loss harvesting, you can take advantage of market volatility to offset capital gains.

When market volatility inevitably ramps up from time to time, riding that roller coaster can sometimes leave you feeling a bit queasy. But that doesn't mean the only thing you can do is close your eyes and hang on until the ride ends. For savvy investors, volatility can actually provide opportunities for agile trading that can be used to their advantage.

For instance, tax-loss harvesting is a powerful tool that may help reduce current tax liabilities for taxable accounts and potentially leave you more to invest over time, but it's a complicated and time-consuming process for individual investors to manage. For many years, this type of sophisticated service was only available to the wealthiest investors. But now, Schwab Intelligent Portfolios^® is able to use the power of technology to automate this complex process for you.

Tax-loss harvesting trades increased during market volatility

While tax-loss harvesting trades have occurred every month since the March 2015 launch of Schwab Intelligent Portfolios, periods of elevated market volatility highlight the potential benefit of the tax-loss harvesting feature. The number of tax-loss harvesting trades across Schwab Intelligent Portfolios accounts that are enrolled in the service have historically surged when markets turn turbulent.

The bear market of 2022 helps illustrate the power of tax-loss harvesting. As Figure 1 shows, the total number of tax-loss harvesting trades across Schwab Intelligent Portfolios rose sharply along with market volatility during the first three quarters of 2022 as the U.S. stock market tumbled. Clients enrolled in tax-loss harvesting were able to capture the losses for tax purposes by selling the ETFs in their portfolio that had declined enough below their purchase price. Additionally, because the tax-loss harvesting feature simultaneously reinvests the proceeds of the sale into an alternate ETF in the same asset class to keep clients invested according to their targeted asset allocation, those clients stayed invested to help benefit from market rebounds.

Figure 1: Tax-loss harvesting trades have increased when markets turned turbulent

tax-loss harvesting chart showing tax-loss harvesting trades have increased when markets turned turbulent

Source: Charles Schwab Investment Management.

The chart shows the total number of tax-loss harvesting events among Schwab Intelligent Portfolio Solutions clients enrolled in the feature over the period from 10/1/2021–9/30/2022.

A tax-loss harvesting case study

To further illustrate how tax-loss harvesting works, we examined the tax-loss harvesting trades that occurred in a Schwab Intelligent Portfolios account during September 2022, one of the most turbulent months during the 2022 volatility. The representative account had a balance of approximately $100,000 and was invested in a globally diversified total return strategy based on a moderate growth risk profile consisting of 57% stocks, 31.5% fixed income, 1% commodities and 10.5% cash.

As shown in Figure 2, the account saw 13 tax-loss harvesting trades in September 2022. Total losses harvested during the month came to approximately $4,548. While not listed in this example, the account experienced tax-loss harvesting trades in most other months of the year as well. During the first nine months of 2022, the account captured nearly $18,000 in tax-loss harvesting trades, or more than 15% of the account value. These captured losses accrue over the course of the year and may potentially be used to help offset realized capital gains when filing year-end tax returns and up to $3,000 in ordinary income to the extent that captured losses exceed an investor's capital gains for the year.

While tax-loss harvesting does not eliminate tax liabilities (future taxes would need to be paid based on the cost basis of the replacement security whenever it is sold at a later date), it defers taxes and can help to potentially reduce current tax liabilities.

This is just an example for illustrative purposes, and the number of tax-loss harvesting trades would likely be lower in a less volatile year. Tax-loss harvesting activity within your account depends on market conditions, when you opened your account, subsequent deposits/withdrawals, whether you switched to a different portfolio after opening the account, and other factors.

Figure 2: Tax-loss harvesting trades during September 2022

Schwab Intelligent Portfolios includes primary and secondary ETFs in each asset class in order to be able to capture losses when the market presents these opportunities while also maintaining your strategic allocation by reinvesting into the alternate ETF in that asset class.


Date	Asset class	Tax-loss harvesting activity	Harvested loss*
9/19/2022	Treasuries	Shares of secondary ETF (IEI) sold** Shares of primary ETF (SCHR) bought	$271.22
9/20/2022	Treasury Inflation Protected Securities (TIPS)	Shares of primary ETF (SCHP) sold Shares of secondary ETF (SPIP) bought	$269.32
9/22/2022	International Developed Markets Small Cap Stocks	Shares of primary ETF (SCHC) sold Shares of secondary ETF (VSS) bought	$283.19
9/23/2022	U.S. Small Company Stocks–Fundamental	Shares of secondary ETF (PRFZ) sold** Shares of primary ETF (FNDA) bought	$379.12
9/23/2022	International Developed Markets Large Company Stocks–Fundamental	Shares of secondary ETF (PXF) sold** Shares of primary ETF (FNDF) bought	$434.87
9/23/2022	Emerging Markets Stocks	Shares of primary ETF (SCHE) sold** Shares of secondary ETF (IEMG) bought	$320.40
9/23/2022	Securitized Bonds	Shares of primary ETF (VMBS) sold** Shares of secondary ETF (MBB) bought	$395.09
9/23/2022	International Developed Market Small Company Stocks–Fundamental	Shares of primary ETF (FNDC) sold Shares of secondary ETF (PDN) bought	$342.72
9/23/2022	U.S. Large Company Stocks–Fundamental	Shares of primary ETF (FNDX) sold Shares of secondary ETF (PRF) bought	$511.75
9/23/2022	International Developed Markets Large Company Stocks	Shares of secondary ETF (VEA) sold** Shares of primary ETF (SCHF) bought	$391.24
9/23/2022	U.S. Large Company Stocks	Shares of secondary ETF (VOO) sold** Shares of primary ETF (SCHX) bought	$381.26
9/26/2022	Emerging Markets Stocks–Fundamental	Shares of secondary ETF (PXH) sold** Shares of primary ETF (FNDE) bought	$323.00
9/29/2022	U.S. Real Estate Investment Trusts (REITs)	Shares of primary ETF (SCHH) sold Shares of secondary ETF (USRT) bought	$245.30
Total	$4,548.48

Disclosure

This example should be interpreted as illustrative only and not representative of an actual client's experience. Tax-loss harvesting is available for clients with invested assets of $50,000 or more in their Schwab Intelligent Portfolios account. Clients must choose to activate this feature. Please be aware that the ability to realize significant tax benefits from tax-loss harvesting depends upon a variety of factors, and no assurance can be offered that a particular investor will in fact realize significant tax benefits.

*Harvested losses take into account the purchase price (cost basis) of the security sold in calculating the amount of the loss harvested for tax purposes.

**Note that the secondary ETF was sold and the primary ETF was purchased in these tax-loss harvesting trades because of previous trades in which the primary ETF had been sold and the secondary ETF purchased. Source: Charles Schwab Investment Management, Inc.

How volatility can work for you

While financial markets are volatile by nature, prepared investors can take action to help make these inevitable fluctuations work for them. Sophisticated portfolio management services such as tax-loss harvesting may help reduce investment taxes and can leave you more money that can be reinvested with the potential to grow over time. With Schwab Intelligent Portfolios, automated tax-loss harvesting is available for accounts with at least $50,000 in investable assets. Clients must choose to activate this feature.

Please read the Schwab Intelligent Portfolios Solutions disclosure brochures for important information, pricing, and disclosures relating to Schwab Intelligent Portfolios and Schwab Intelligent Portfolios Premium programs.

Schwab Intelligent Portfolios^® and Schwab Intelligent Portfolios Premium^® are made available through Charles Schwab & Co., Inc. ('Schwab'), a dually registered investment adviser and broker-dealer. Portfolio management services are provided by Charles Schwab Investment Management, Inc. ("CSIM"). Schwab and CSIM are subsidiaries of The Charles Schwab Corporation.

There is no advisory fee or commissions charged for Schwab Intelligent Portfolios. For Schwab Intelligent Portfolios Premium, there is an initial planning fee of $300 upon enrollment and a $30-per-month advisory fee charged on a quarterly basis as detailed in the Schwab Intelligent Portfolios Solutions disclosure brochures. Investors in Schwab Intelligent Portfolios and Schwab Intelligent Portfolios Premium (collectively, “Schwab Intelligent Portfolios Solutions”) do pay direct and indirect costs. These include ETF operating expenses which are the management and other fees the underlying ETFs charge all shareholders. Schwab does not charge an advisory fee for the SIP Program in part because of the revenue Schwab Bank generates from the cash allocation (an indirect cost of the Program). The portfolios include a cash allocation to FDIC‐insured Deposit Accounts at Charles Schwab Bank, SSB ("Schwab Bank"). Schwab Bank earns income on the deposits, and earns more the larger the cash allocation. The lower the interest rate Schwab Bank pays on the cash, the lower the yield. Some cash alternatives outside of Schwab Intelligent Portfolios Solutions pay a higher yield. Schwab Intelligent Portfolios Solutions invests in Schwab ETFs. A Schwab affiliate, Charles Schwab Investment Management Inc., receives management fees on those ETFs. Schwab Intelligent Portfolios Solutions also invests in third-party ETFs. Schwab receives compensation from some of those ETFs for providing shareholder services, and also from market centers where ETF trade orders are routed for execution. Fees and expenses will lower performance, and investors should consider all program requirements and costs before investing. Expenses and their impact on performance, conflicts of interest, and compensation that Schwab and its affiliates receive are detailed in the Schwab Intelligent Portfolios Solutions disclosure brochures. Certain conditions must be satisfied for FDIC insurance coverage to apply. Charles Schwab & Co., Inc. and Charles Schwab Investment Management Inc. are not FDIC-insured banks and deposit insurance covers the failure of an insured bank.

Schwab Intelligent Portfolios^® and Schwab Intelligent Portfolios Premium^® are designed to monitor portfolios on a daily basis and will also automatically rebalance as needed to keep the portfolio consistent with the client's selected risk profile. Trading may not take place daily.

This information provided here is for general informational purposes only, and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, you should consult with a qualified tax advisor, CPA, Financial Planner, or Investment Manager.

Tax‐loss harvesting is available for clients with invested assets of $50,000 or more in their account. Clients must choose to activate this feature. The tax‐loss harvesting feature available with Schwab Intelligent Portfolios Solutions is subject to limitations which are described on the Schwab Intelligent Portfolios Solutions website and mobile application (collectively, the "Website") as well as in the Schwab Intelligent Portfolios Solutions disclosure brochures (the "Brochures"). You should consider whether to activate the tax‐loss harvesting feature based on your particular circumstances and the potential impact tax‐loss harvesting may have on your tax situation. Please read the tax‐loss harvesting disclosures on the Website and in the Brochures before choosing it. Neither the tax‐loss harvesting strategy, nor any discussion herein is intended as tax advice, and neither Charles Schwab & Co., Inc. nor its affiliates, including but not limited to Charles Schwab Investment Management, Inc., represents that any particular tax consequences will be obtained. For more information please visit the IRS website at www.irs.gov.

Diversification, asset allocation, automatic investing and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.

Past performance is no guarantee of future results.

Nothing in these materials represents a recommendation of a particular ETF.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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