Tax-loss strategies, or the selling of investments to claim losses, are a popular way investors can reduce the taxes they owe. These strategies can potentially improve the after-tax return of an investment portfolio. But unless they are executed optimally, they may cause investors to lose out on significantly better investment returns.
For struggling securities, a spike of tax selling pressure has the potential to overwhelm the issue’s buying support, sending prices lower still. Tax-loss sales typically concentrate on investments that have sizable losses, which often means that these sales focus on a relatively small number of securities within the public markets.
Sometimes falling prices indicate a major problem with the investment, and investors are well advised to eliminate the holding – especially when the rest of the market/sector is moving higher.
Those who feel compelled to take losses late in the year should at least try to sell early enough to repurchase the shares before year-end. While repurchases made late in the year may not offer the best possible prices, investors who repurchase before the year ends can potentially benefit from whatever bounce occurs after the first of the year.
Be careful to note, however, that the “wash sale” rules will prevent recognition of the loss if a substantially identical security is purchased 30 days before or after the “loss” sale. Since there are complex rules regarding wash sales, investors should carefully review any tax-loss strategy with their tax advisor.