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Product - December 6, 2018

Tax-Loss Harvesting Made Simple with YCharts

Tax-loss harvesting is a process, usually conducted annually, whereby investors seek to limit their portfolios’ capital gains taxes.

Assuming you sold investments for a capital gain at some point in the year and will owe taxes on those gains, you may choose to sell other investments at a loss and offset the taxable income made by selling the winning investments.

The goal, and result when done correctly, is improved after-tax returns. However, in order to maintain your desired exposures and not miss out on any potential gains, you need to replace what was sold with similar assets.

For example, let’s say we accrued capital gains in our portfolio this year and want to limit taxes paid on those gains. We sell Coca-Cola (KO) to incur a capital loss and receive a tax credit; however, we still want Consumer Defensive exposure, and in particular, exposure to the beverage industry. As such, we simultaneously buy PepsiCo (PEP) to maintain our desired exposures and hoping that if Coca-Cola were to go up in value, so would a very similar stock, PepsiCo.

To show how YCharts can assist with your tax-loss harvesting efforts, we’ve put together a sample workflow for you below. (Note: We always recommend discussing any tax strategies with a CPA; this article provides only a hypothetical example of tax-loss harvesting)

  1. Identify your losers

The first step in tax-loss harvesting is identifying stocks we can sell at a capital loss. Assume our portfolio has the holdings shown below. Using the YCharts Comp Tables, we can see which holdings have lost value over multiple periods:

Several holdings in this portfolio have performed extremely well, and assuming we’ll cash-in on those gains this year, our portfolio will incur capital gains taxes.

In order to offset those taxes, we want to sell some of our losing positions for tax credits, which will limit taxes paid and increase after-tax returns.

2. Find suitable alternatives

According to IRS regulations, we are not permitted to sell and then buy back the same or a “substantially identical” asset within a 30 day period for the sole purposes of paying less in taxes. This is called the “wash-sale rule”. To avoid violating the wash-sale rule, advisors often wait 30 days and/or find an alternative, correlated security to maintain the desired exposures for the time being.

Finding alternative investments to swap out in place of losers is simple with the YCharts Stock and Fund Screeners.

Hypothetically, let’s say we sold positions earlier in the year at a profit and as a result, are expecting substantial capital gains taxes. To offset these taxes, we’ve chosen to sell our positions in IBM (IBM) and AT&T (T) at a loss, temporarily replace them, and limit our taxes owed.

Equity Alternative for IBM

When we sell IBM to receive tax credits for capital losses, we don’t necessarily want to give up exposure to the Technology sector, or even the more-drilled down Information Technology Services sector.

Using the YCharts Stock Screener, we can filter for Information Technology Services companies and set a floor for Market Cap since IBM is a large-cap company. We then add metric columns for historical returns and 3-Year Beta to find like-performing stocks. See below.

After running this screen and sorting for “1 Year Total Returns (Daily)”, we see that NCR Corp (NCR), with historical performance and a 3-Year Beta very similar to IBM, would be a suitable alternative.

The goal of this exercise is to ensure we don’t miss out on any potential gains that IBM might see after we sell our shares. By holding NCR, a very similarly performing company, we hope that we can capture most or all of any upside for IBM.

Fund Alternative for AT&T

When searching for an alternative for AT&T, we use the YCharts Fund Screener to set a Security Exposure Filter, limiting the results to funds with a certain percentage of holdings, here 10%, in AT&T.

Also within the YCharts Fund Screener, we can set filters for ETFs and mutual funds that target the Telecommunication Industry. See the filters we have set below.

With just two filters applied, we have a short list of six ETFs and mutual funds that we can use to replace AT&T in our portfolio. When comparing expense ratios and potential capital gains (which could be risky to pick up at year-end), the Fidelity MSCI Communication Services ETF (FCOM) appears to be the least-expensive proxy and also weights AT&T at 21.01% of its holdings.

3. Evaluate your exposures

In summary, we’ve sold IBM at a loss, received a tax credit while doing so, and replaced it in our portfolio with NCR Corp for the time being. We also sold AT&T for a loss and replaced it with the Fidelity MSCI Comm Services ETF.

Using YCharts Model Portfolios, we can analyze our results to ensure we’ve maintained our desired exposures.

Our Stock Sector Exposures remained virtually identical. See below.

Shown below, our stock style exposure did tilt as we sold large cap exposure, IBM, and added the much smaller NCR; however, our exposures are still comparable.

Using various YCharts tools, we completed a simple and scalable exercise as part of our tax-loss harvesting process. We identified holdings we could sell to offset capital gains, we filtered universes of both equities and funds to find suitable alternative holdings, and we quantified the effects those transactions would have on our portfolio’s exposures.

To see more ways YCharts can simplify your investment process, visit YCharts.com for a free trial.

Disclaimer: The content of this article is meant for educational purposes only and is not intended to be used as investment advice, nor is YCharts acting as an advising party regarding client funds in any way.

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