Selling a fund with unrealized losses allows you to offset capital gains
elsewhere in the portfolio. If you harvest losses regularly, you can save
thousands of dollars over the years. Many financial advisors use
exchange-traded funds (ETFs) in tax-swapping strategies because they are
easily traded, diversified, and tax-efficient. There might be multiple ETFs
tracking a particular segment of the market, such as large-capitalization
stocks.
For example, two popular ETFs track large-company U.S. stocks: S&P 500 SPDR
(SPY) and iShares Russell 1000 (IWB). You can hold on to one of these ETFs,
take a loss if it drops, and switch to the other. This approach allows you
to take a tax loss while remaining invested in large-caps, so as not to miss
any rally. A similar strategy in the small-cap asset class might use the
iShares Russell 2000 Index (IWM) and iShares SmallCap 600 Index (IJR).
These ETFs probably will not be considered “substantially identical” by the
IRS. However, if you swap between two ETFs tracing the same index, the loss
might not be recognized, for tax purposes.
ETFs may be more effective than mutual funds for frequent harvesting or
portfolio rebalancing because they don’t charge redemption fees for
short-term trading. Some mutual funds impose fees for shares bought and sold
quickly.
