Winning by Losing: How Tax Harvesting Can Help Successful Graduates Avoid Heavy Market Losses
Walk into a casino and look around: what you’ll see, if you can get past the blinking lights, clanging noises, and general murmur of excitement, is that everyone has a strategy. Few walk into a casino without one. For some, it’s as simple as “always bet on black” or “find a lucky slot machine and don’t move for five hours.” Others have a more complex system for beating the house. Few of these strategies actually work, but the word “strategy” is value-neutral: really bad ones count too.
The best strategies are actually the least complicated, and don’t even revolve around a specific game (except blackjack – you could engage in hundreds of hours of rabbinical-level conversation about when to hit and when to stay). Rather, they’re all about when to walk away; about finding an upper limit and a bottom line to the amount of money you’re willing to lose. If you have those figures in mind, and stick to them, you’ll be fine.
Investing in the markets requires a similar mindset. If you are new to investing, especially if you’re a successful college graduate with some money to spend, you may be tempted to try to find the perfect investment – essentially, to put a big stack on red and let ‘er ride. While that may be thrilling, and sometimes even work, it isn’t a sustainable way to manage your money. As in a game of poker, the key is to maximize what you get from your wins while minimizing the amount of losses. One way to achieve the latter is to engage in tax harvesting.
What is tax harvesting?
“Tax harvesting,” frankly, is a terrible name. It conjures up images of farmers raising a crop of taxes, which wouldn’t be very tasty at all. But in reality, it’s a really interesting strategy that aims to make your losses in the market helpful by using them to cancel out capital gains taxes.
Capital gains are essentially what you get when you make money from selling a stock, bond, or other asset. So if you buy 500 shares of Amalgamated Spats at $10 a share, and sell them at $15, you’ve made $2500. That amount is taxable, so when doing your finances, you can’t be thinking that you suddenly have an extra $2500 in your pocket. There are a couple of factors that determine how much you’ll be taxed, including your current tax bracket and whether you’ve held the stock long or short term (short term is under a year).
You can argue whether or not this is fair, but that argument won’t change the underlying taxes. However, like with poker, you can figure out a way to minimize these gains in the eyes of the IRS. One potential strategy is by losing elsewhere.
Not all of your investments are going to work out. When they don’t, you have two options: (1) sit on the investment and hope it comes back; or (2) sell it and take the loss. The latter is a form of tax loss harvesting: selling investments at a loss to either create deductible losses or to minimize or remove capital gains tax liability. If you sold a position for tax purposes but ultimately wish to maintain exposure to that position, you can reinvest the funds in another, similar investment. Just be careful not to repurchase the exact same security within 30 days or your loss may be disallowed. Ultimately, tax loss harvesting can help you to avoid the higher taxed short-term capital gains and mitigate the pain of selling an investment at a loss.
Granted, this means you have to have money in a few different places, and that might not always be feasible. It is the smart thing to do, though. Along those lines, if you happen to have student loans, the interest on those loans may be tax deductible as well. Whether or not you’re below the threshold to deduct that interest, you might still want to look into refinancing your student loans through a service like SoFi.
Always use caution
Don’t forget that there are as many tax strategies and “beat the market” advice books as there are “win big at poker” guidebooks online. Just remember the old axiom: anyone who figured out how to beat the market isn’t going to waste their time writing a book about it. They’ll be on a private spacecraft or something. There is no such thing as a surefire strategy, and you should always consult with experts for advice before making any moves.
When dealing with finances, you have to be smart and cautious. By tinkering at the margins, you can work to minimize losses. Over the years, this adds up. The whole point is not to retire tomorrow, but to make sure that your eventual retirement is comfortable and that you can provide for your loved ones. In Vegas, the house always wins. But if you are smart about your money, you can be the house.