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    Tax-Loss Harvesting Strategies: How They Work

    Taxes: They can’t be avoided. But they can be managed. A tax-loss harvesting strategy may help you keep more of what you earn. Find out how it all works and why we think a customizable separately managed account can be an effective way to potentially maximize tax efficiency.

     
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    What is tax-loss harvesting?

    Simply put, tax-loss harvesting is a strategy designed to potentially reduce your overall tax bill so you can keep more of what you earn from your investments. It works by selling investments at a loss and using those losses to offset some, or possibly all, of the capital gains from investments that you sold at a profit. For example, if an investor buys a stock at $400 and sells it for $500, they realize a capital gain of $100. This will trigger a capital gains tax (the amount will depend on variables such as the investor’s marginal tax rate, state and local tax rates and how long they held the stock). However, if the investor sells another security at a $100 loss, they can use that realized loss to offset the gain from the sale of the other stock. As a result, the net realized gain is reduced and the investor’s overall tax bill is lowered. 

     

     

    OK, how might I apply tax-loss harvesting in an equity strategy?

    We think the best vehicle is a customizable separately managed account, or SMA, which may allow a manager to reduce your tax bill by “harvesting” losses while maintaining broad market exposure.  

     

     

    Here’s how it works: 

    1. The SMA seeks to provide market-like returns through direct indexing, by purchasing a portfolio of diverse1  stocks resembling the broad equity market.  

    2. The manager opportunistically sells stocks throughout the year that are trading at a loss. This happens when the stock price falls below the price at which it was purchased, also known as the investment’s “cost basis.” 

    3. The manager then replaces those stocks with securities that have similar risk and return characteristics. For example, they may decide to sell the stock of a large financial institution that is trading at a loss and replace it with another stock or set of stocks—perhaps those issued by other large banks. 

     

    The realized losses are then used to offset capital gains incurred in other parts of the investor’s portfolio. 

     

    There are many ways for investors to end up with a tax bill at year end. Examples include investment gains from other active managers, capital gains distributions from mutual funds, selling appreciated real estate, private equity distributions or investing in hedge funds which may not be tax efficient. 

     

     

    So the manager’s job is to pick losing stocks?

    No, not at all. The purpose of tax loss harvesting is not to pick losing stocks. It is simply to potentially help investors benefit from naturally occurring market volatility and dispersion in stock returns. Think about it this way: even in years when an index such as the S&P 500 delivers a positive return, not every single stock in the index has a positive return throughout the year. Some stocks experience losses throughout the year and may even end the year in the red. 

     

    While market returns vary from year to year, market volatility is a constant. Volatility and dispersion of stocks returns create potential opportunities to harvest losses which adds value to an investment portfolio by potentially increasing after-tax returns. Of course, the amount of potential tax savings depends on the market environment— typically, a year with low market returns will provide more harvesting opportunities than a high return year. But we believe tax-loss harvesting may work in any market environment because losses exist in all market environments.

     

     

    Losses Exist in All Markets

    Tax-loss harvesting seeks to provide value in all market environments.

     
    SMA

    Source: Goldman Sachs Asset Management, Standard and Poor’s. As of December 31, 2023. There is no guarantee that these objectives will be met. Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this presentation. Past performance does not guarantee future results, which may vary.

     

     

    Aren’t other passive vehicles, such as ETFs and index funds, also tax efficient? What’s different about a tax-managed SMA?

    ETFs generally have low expenses, and most are passively managed and structured to track an index. But when it comes to tax efficiency, there are three key differences.  

     

    1. An ETF or index fund investor owns shares in a fund that tracks an index. With an ETF, an investor may only harvest a loss when the entire index is down.  In contrast, the SMA investor directly owns many of the individual securities in the broad equity market. This is sometimes referred to as “direct indexing”. By owning all of the underlying securities, a manager can harvest losses when the index is down but can also opportunistically sell individual stocks trading at a loss in pursuit of higher tax savings and after-tax returns compared to an ETF.

    2. In an ETF or an index fund, all realized losses within the fund can only be used to offset realized gains within the fund. Whereas realized losses in a SMA, as noted earlier, can be used to offset gains anywhere else in an investor’s portfolio. This can potentially add up to greater tax savings. (For more on ETFs see disclosures)

    3. SMAs can generally be funded with both cash and in-kind stock contributions. Existing stock positions in an investor’s portfolio can be transitioned in-kind into an SMA and managed with greater tax efficiency.

     

     

    What are the long-term potential benefits for an investment portfolio?

    When repeated in a systematic way, year in and year out, tax-loss harvesting can potentially reduce your tax bill. That means an investor is not only saving money on their taxes in a given year, but they can reinvest those tax savings for potential growth in the future. And the longer a portfolio stays invested, the more time it has to grow and compound.  

     

     

    Can any type of investor potentially benefit from tax-loss harvesting strategies?

    All taxable investors may potentially benefit from tax-loss harvesting strategies and investors in the highest tax brackets stand to potentially benefit the most. This is because the higher the tax bracket, the bigger the potential savings. It also helps to have capital gains from other parts of an investor’s portfolio. This could include gains from selling down concentrated stock, private equity or other active managers. If an investor doesn’t have capital gains from other investments in a particular year, harvested losses can be used to offset $3,0002  in ordinary income per year. This includes interest, wages, dividends and net income from a business. Any excess losses can be carried forward indefinitely and used to offset capital gains in the future.

     

    Investors who may want to consider tax-loss harvesting include those who plan to donate their portfolio to charity or bequest it to heirs, as this would not involve realizing capital gains. Investors who plan to liquidate their portfolio eventually would then pay taxes on realized gains. But if they employed tax-loss harvesting over a long investment horizon, they may find that the portfolio appreciated more than it would have had it been invested in an index strategy without tax management.

     

     
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    1 Diversification does not protect an investor from market risk and does not ensure a profit.
    2 See Capital Losses: https://www.irs.gov/pub/irs-pdf/i1040sd.pdf

    To explore how we can help you with tax-advantaged investment opportunities visit our GSAM Tax-Advantaged Strategies webpage.

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    Glossary

    Separately Managed Account (SMA): A portfolio of individual securities managed on an investor’s behalf by a professional asset management firm. Because the investor owns the underlying securities, and SMA provides more control than other investment vehicles and can be customized to fit individual investor needs.


    ETF: A type of security that tracks an index, sector, commodity or other asset but can be purchased or sold on an exchange, like an individual stock.

    Capital Gains: An increase in an asset's value, which for tax purposes is considered to be realized when the asset is sold. A capital gain may be short-term (one year or less) or long-term (more than one year) and must be claimed on income taxes.

    S&P 500: The S&P 500 Index is the Standard & Poor's 500 Composite Stock Prices Index of 500 stocks, an unmanaged index of common stock prices. The index figures do not reflect any deduction for fees, expenses or taxes. An investor cannot invest directly in an unmanaged index.

    Dispersion refers to the range of possible returns on a type of investment.

    In-Kind Stock Contributions refer to transactions in which an investor moves assets from one brokerage account to another as-is. There's no selling off assets or buying new ones.

    Compounding: The process in which the earnings on an asset are reinvested to generate additional earnings over time.

    Investment Portfolio: A collection of financial investments such as stocks, bonds, real estate, etc.

    Ordinary Income: Income earned by an individual or organization, such as wages, salary, bonuses, rents and royalties, that is taxed at ordinary rates.

    Risk Considerations

    Equity investments are subject to market risk, which means that the value of the securities in which it invests may go up or down in response to the prospects of individual companies, particular sectors and/or general economic conditions. Different investment styles (e.g., “growth” and “value”) tend to shift in and out of favor, and, at times, the strategy may underperform other strategies that invest in similar asset classes. The market capitalization of a company may also involve greater risks (e.g. "small" or "mid" cap companies) than those associated with larger, more established companies and may be subject to more abrupt or erratic price movements, in addition to lower liquidity.

    Disclosures          

    THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO.

    Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant.

    Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice

    There is no guarantee that objectives will be met.

    Goldman Sachs does not provide legal, tax or accounting advice, unless explicitly agreed between you and Goldman Sachs (generally through certain services offered only to clients of Private Wealth Management). Any statement contained in this presentation concerning U.S. tax matters is not intended or written to be used and cannot be used for the purpose of avoiding penalties imposed on the relevant taxpayer. Notwithstanding anything in this document to the contrary, and except as required to enable compliance with applicable securities law, you may disclose to any person the US federal and state income tax treatment and tax structure of the transaction and all materials of any kind (including tax opinions and other tax analyses) that are provided to you relating to such tax treatment and tax structure, without Goldman Sachs imposing any limitation of any kind. Investors should be aware that a determination of the tax consequences to them should take into account their specific circumstances and that the tax law is subject to change in the future or retroactively and investors are strongly urged to consult with their own tax advisor regarding any potential strategy, investment or transaction.

    Index Benchmarks

    Indices are unmanaged. The figures for the index reflect the reinvestment of all income or dividends, as applicable, but do not reflect the deduction of any fees or expenses which would reduce returns. Investors cannot invest directly in indices.

    The indices referenced herein have been selected because they are well known, easily recognized by investors, and reflect those indices that the Investment Manager believes, in part based on industry practice, provide a suitable benchmark against which to evaluate the investment or broader market described herein. The exclusion of “failed” or closed hedge funds may mean that each index overstates the performance of hedge funds generally.

    References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. The index composition may not reflect the manner in which a portfolio is constructed. While an adviser seeks to design a portfolio which reflects appropriate risk and return features, portfolio characteristics may deviate from those of the benchmark.

    ETFs: Since ordinary brokerage commissions apply for each ETF buy and sell transaction, frequent trading activity may increase the cost of ETFs. While extreme market conditions could result in illiquidity for ETFs, typically, some are more liquid because they trade on exchanges.

    Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.

    This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. This material has been prepared by GSAM and is not financial research nor a product of Goldman Sachs Global Investment Research (GIR).  It was not prepared in compliance with applicable provisions of law designed to promote the independence of financial analysis and is not subject to a prohibition on trading following the distribution of financial research. The views and opinions expressed may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates.  Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates or changes.

    Economic and market forecasts presented herein reflect a series of assumptions and judgments as of the date of this presentation and are subject to change without notice.  These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client.  Actual data will vary and may not be reflected here.  These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes.  These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.

    This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.

    The website links provided are for your convenience only and are not an endorsement or recommendation by GSAM of any of these websites or the products or services offered. GSAM is not responsible for the accuracy and validity of the content of these websites.

    Confidentiality

    No part of this material may, without GSAM’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.

    Date of first use: March 15, 2024.

    361727-TMPL-03/2024-1989884

    © 2021 Goldman Sachs. All rights reserved.

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