Investing in index funds is known as “passive” investing because you’re not relying upon a mutual fund manager who’s actively picking stocks. However, passive investing does not mean to buy and hold forever.
Instead, when one segment of the stock market suffers a significant reversal and the corresponding index takes a loss, you should sell that index fund, if it’s held in a taxable account and if a sale will give you a taxable loss.
The proceeds may be reinvested in the same type of index: Buy a fund that’s similar but not identical and hold the new fund for at least 31 days, to avoid the “wash sale” rule. That rule disallows tax losses if you reinvest in the securities you’ve just sold.
The proliferation of index funds encourages this type of loss harvesting. You might, for example, sell an S&P 500 mutual fund, if you’re holding it at a loss, and then reinvest in an exchange-traded fund that tracks a total stock market index. Exchange-traded funds are index funds that trade like stocks; go to www.morningstar.com
