Back in the 1980s, the first mobile phones—clunky devices that weighed as much as a brick and looked like one too—were things only the very few owned. And all they did was make calls—no texting, no web browsing, and certainly no playing Fortnite.
Nowadays, according to 2018 data from the Pew Research Center, 95% of the US population owns some sort of cell phone, and 77% own a smartphone.
It’s not the only invention from the previous millennium that was once tailored to a very small subset of the population and now appears to be undergoing something of a democratization. Tax-loss harvesting, a strategy Parametric helped pioneer back in the early 1990s, has begun to migrate from the realm of specialty practice to the broader world of investment advisory. More and more retail firms are touting its benefits to more and more clients. After all, if tax-loss harvesting is good for some investors, it must be good for all investors, right?
Well, frankly, maybe not. As with early mobile phones, we have a classic case of a bad connection here—and recent media articles have only added to the static.
Tax-loss harvesting in the news
“Beware the Bold Claims of Tax-Loss Harvesting” warned an April 13 headline in the Wall Street Journal. It came on the heels of a December 2018 enforcement by the SEC against Wealthfront, a robo-advisor the agency accused of making false statements about its tax-loss harvesting strategy that also attracted a good deal of media attention. Some in the industry took these stories to mean that the entire enterprise of tax-loss harvesting was snake oil—that investors were being hoodwinked into thinking they could generate alpha by loss-harvesting at any opportunity to do so.
Of course, if you actually read the stories behind the headlines, that’s not what they’re saying. What they are saying is that tax-loss harvesting, unlike a cell phone, is neither easy nor offers the same benefits for everybody. And that those touting its efficacy for all investors may be guilty of overselling the strategy.
Tax-loss harvesting isn’t for every investor
As with everything else in the finance universe, tax-managed investing isn’t a free lunch. At heart, tax-loss harvesting is a trade-off between risk and return. In this respect it’s no different from any other investment decision, and investors must evaluate tax-loss harvesting accordingly.
For example, are you comfortable vacating a position to harvest a loss, or is there risk in being out of a position that potentially exceeds the tax benefit? If so, how might you mitigate that risk? If you sell out of multiple positions to harvest losses, are you comfortable with the effect it might have on the portfolio’s overall tracking error? The answers may be different for every investor, and in our experience the risk-return trade-off ends up favoring certain types of investors. To the extent the average investor is being told to harvest losses in knee-jerk fashion, they’re being done a disservice.
Once again tax-loss harvesting feels like the shiny new thing in the industry. (Even though it really isn’t.) And like many shiny new things, it’s both benefiting and suffering from all the hype. We say hold the phone. Tax-loss harvesting can be a powerful tool that helps advisors provide more value to their clients, but it’s not a one-size-fits-all solution. It’s not even a many-sizes-fit-all solution. Instead it’s more accurate to think of it as a many-sizes-fit-most approach.
You may have clients that will benefit greatly from tax-loss harvesting. You may have some that will see only modest, but significant, benefit. And you may have still others that will see no benefit at all. Overpromising what tax-loss harvesting offers doesn’t do those clients any favors.