Make Money In Down Markets: Harvest Tax Losses With ETFs

If you have exposure to an asset class, it’s important to
maintain that exposure and not try to become a fortune-teller, attempting to figure
out when to “get in or get out.” The
famous professors at Yale have proven that asset allocation accounts for 90% of
a portfolio’s return and that stock picking and market timing account for less
than 10%. Many studies also show that
large up moves in the market happen quick and just a few days over many years,
account for most of the gains that markets achieve. So trying to time a market – particularly in
these volatile times, is a fool’s errand.

But there is something you can do during a downtown to pick
up a little extra return besides shorting stocks. ETFs are unique vehicles for helping with the
tax bill in large market downturns such as the one we are experiencing. Did you know that you can sell an ETF for a
loss and buy a similar one that gives you substantially the same exposure, and
take a tax deduction?

Let’s say that in 2007 you decided to build portfolio exposure
to emerging market countries. In a
taxable account, you purchased the iShares
MSCI Emerging Markets Index (EEM) – or you bought an emerging markets mutual
fund.

Assume that today your investment is down (10%) from the
recent global equities correction. You
still want to maintain the emerging markets exposure, not become a market
timer, but still benefit from the loss you’ve incurred.

In our above example, simultaneously sell EEM, take your 10%
loss and buy Vanguard’s VWO. If you
compare EEM and VWO, over the last 2 years, they are substantially similar
ETFs. They practically move together,
hold many of the same companies, and are allocated amongst the same countries
in almost the same proportion. But you’ve
now created a tax loss without triggering “wash sale” rules. The only expense might be $20 of online
brokerage fees. If you’ve come to love EEM
and simply can’t stomach owning VWO, then reverse the transaction in 31 days!

Before ETFs, getting this type of tax-loss benefit was
virtually impossible. You simply can’t
do it with mutual funds because they are not easy to sell, they are structured
as “funds” so you can’t easily track tax lots, and you pay taxes based upon the
redemptions going on inside the fund. Conversely, ETFs are like any “stock” and you can easily figure out
which shares to sell based upon tax lots. One caveat – check with your CPA to confirm that this works for your
situation. I’m not licensed to give tax
advice.

There are many sites to help you figure out which ETFs are
comparable to the ones that you currently own. On MarketRiders, our portfolio engine has easily classified all
ETFs but you can find this information on SeekingAlpha, XTF, Index Universe,
and Yahoo. It takes a little work, but it’s
clearly worth the effort and might make you feel a little better during the
current downturn. ubuntu ftp server Switonperkerbti