How to help make sure you keep more of what you earn

Anyone who has ever asked for investing advice has probably been told to be patient, to hang on through short-term volatility, and not to time the market. This is wise counsel. But when you’ve decided to sell an underperforming security, timing becomes important.

As informed investors know, once you sell a winning investment, the gain is generally taxed at rates of 20% to 40% (depending on whether the gain is long-term or short-term). Here’s what is less well-known: there are ways to generate losses to make a portfolio more tax-efficient, allowing investors to hold onto more of their gains.

The method is called tax-loss harvesting. Short-term volatility can provide opportunities to use it to potentially enhance an investor's potential tax savings.

What is tax-loss harvesting and how does it work?

Tax-loss harvesting is a strategy that uses the capital losses from one investment to offset taxes owed on profits (or capital gains) from another investment. Here’s how it works:

1. Identify stocks that have lost value since you purchased them
2. Sell these, and reinvest in substitutes that keep your overall portfolio in-line with its objectives¹
3. Lower your taxes owed on realized capital gains

How tax-loss harvesting can accelerate growth

An active tax management approach could help you reach your wealth goals faster. Let’s look at the investment journey of Sonia Cheema to help illustrate the difference that tax-loss harvesting can have on a portfolio.

Sonia invests $100,000 in a stock, and over the course of a month it loses $40,000 in value. She sells her remaining holdings at $60,000, resulting in  a $40,000 loss. Then she finds a similar, not identical, stock and buys $60,000 worth.

Sonia can use her reserve of losses to offset realized capital gains in other parts of her portfolio. In this case, the $40,000 capital loss can be worth up to $16,320 in potential tax savings)².¹

She repeats this process every time she sees an opportunity to harvest a loss in her portfolio. She still keeps her portfolio aligned to her objectives – with a potentially lower tax bill at the end of the year. We call that being Tax-Smart.

How and when should you use tax-loss harvesting?

It might seem like down markets will produce more opportunities to harvest losses, and that’s true to an extent. Given the natural dispersion in the market combined with the power of technology, the harvesting of losses and their replacement with comparable stocks can now be done on a systematic, ongoing basis. Robust technology now enables us to monitor accounts daily, capturing losses throughout the year. This greatly enhances the effectiveness of tax-loss harvesting.

Even when the overall stock market is rising, it can produce meaningful opportunities for capturing tax losses. For example, the S&P 500 index returned an average of 18% annually between 2017 and 2021, but in each of those years, around 140 stocks on average posted negative annual returns. This created numerous opportunities to harvest tax losses.

Test for Subhead 2

Ultimately, what matters isn’t whether the market is up or down. It’s the natural, ongoing volatility of equity markets, which creates both gains (to protect) and losses (opportunities to reduce taxes).

To make sure you are getting the most out of your tax-loss harvesting strategy, make sure it's year round. Markets are always moving and this can create potential opportunities to harvest losses all the time.

The combination of the benefits of tax-loss harvesting and the consistency of new technology is attracting a lot of interest from high net worth and ultra-high net worth individuals. J.P. Morgan Private Bank’s Tax-Smart strategies have accumulated more than $12 billion³ in client assets within two years of launching.

We can help

If you would like to know more about how to implement a tax-loss harvesting strategy in your investment portfolio, consider talking to your J.P. Morgan team. We are here to help.

¹When preparing to making these sales, it’s important to be aware of the “wash sale” rule. If you sell a security at a loss and buy the same security, or a substantially identical one, within 30 calendar days, you cannot to take a loss for that security on your current-year tax return. This means you won’t be able to harvest the loss for tax purposes. The rule applies to purchases made 30 days before OR after the sale.

²This calculation is based on the $40,000 loss offsetting short-term capital gains that would otherwise be taxed at a 37% U.S. federal marginal income tax rate and subject to the 3.8% surtax on net investment income, for a combined rate of 40.8%. State income taxes are not included in this hypothetical example.

³J.P. Morgan Private Bank AUM as of May 29, 2024.