Overcoming Volatility with Tax-loss Harvesting
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
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 |
| $271.22 |
| 9/20/2022 | Treasury Inflation Protected Securities (TIPS) |
| $269.32 |
| 9/22/2022 | International Developed Markets Small Cap Stocks |
| $283.19 |
| 9/23/2022 | U.S. Small Company Stocks–Fundamental |
| $379.12 |
| 9/23/2022 | International Developed Markets Large Company Stocks–Fundamental |
| $434.87 |
| 9/23/2022 | Emerging Markets Stocks |
| $320.40 |
| 9/23/2022 | Securitized Bonds |
| $395.09 |
| 9/23/2022 | International Developed Market Small Company Stocks–Fundamental |
| $342.72 |
| 9/23/2022 | U.S. Large Company Stocks–Fundamental |
| $511.75 |
| 9/23/2022 | International Developed Markets Large Company Stocks |
| $391.24 |
| 9/23/2022 | U.S. Large Company Stocks |
| $381.26 |
| 9/26/2022 | Emerging Markets Stocks–Fundamental |
| $323.00 |
| 9/29/2022 | U.S. Real Estate Investment Trusts (REITs) |
| $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.