Year-End Tax Planning: An Explanation of Tax-Loss Harvesting

As we approach the year-end, seasoned advisors are gearing up for the annual ritual of tax-loss harvesting, a strategic maneuver aimed at optimizing client portfolios. Recently, the utilization was somewhat muted due to the high correlation of most asset classes – rising and falling in unison. However, 2023 presents a compelling opportunity for investors holding appreciated stocks alongside bonds that find themselves significantly underwater as a result of rapidly rising interest rates.

In the current landscape, the game plan may involve swapping underwater bonds for similar risk-profile bonds with meaningful higher yields while at the same time harvesting a “tax loss” that can be used to offset gains in other areas of the portfolio, such as appreciated stocks. While this tactic is well-documented and may not be breaking news, the twist in 2023 lies in the compounded effect, especially when considering the opportunity to upgrade portfolio yields and reduce tax burdens.  (Note: tax loss carryforwards do not expire and can be used to offset future gains as well.)

However, the proverbial fly in the ointment is the inverted yield curve, which complicates the decision-making process. The natural inclination may be to sell bonds with longer maturities and durations, opting instead for shorter-term bonds with higher yields. But beware, as this seemingly prudent move could backfire when interest rates take an unexpected nosedive, resulting in a whipsaw effect. Investors may find themselves taking a loss on the bonds without reaping the benefits of a subsequent increase in value.

In navigating this complex landscape, it may be prudent to match the duration of the sold and bought bonds for harvesting losses. This strategic move aims to mitigate the risks associated with an inverted yield curve, providing a more balanced and thoughtful approach to tax-loss harvesting in 2023.

In conclusion, while the annual tradition of tax-loss harvesting is a well-established practice, the nuances of each year's market conditions demand a keen understanding and a flexible strategy. In 2023, the opportunity to pair loss harvesting with a careful reinvestment strategy in the bond market creates a distinctive chance for investors to optimize their portfolios in the face of a unique financial landscape.

As we delve into this year's year-end maneuvers, our aim is to approach the process with wisdom, finesse, and the understanding that our clients’ portfolios and overall tax circumstances differ.

If you have any questions or concerns, please reach out to your First Bank Wealth Management Team.

Matt Belfanti, MBA, CFP®, CLU®, is a Family Wealth Advisor for First Bank Wealth Management. Possessing nearly 20 years of experience in financial services and a deep knowledge of succession planning for multi-generational family owned businesses, you may contact Matt Belfanti at (949) 476-3255 or via email at [email protected]