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Tax-Trimming Strategies Tailored for the ETF Investor

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For ETF investors bearing the brunt of a down market in 2022, tax-loss harvesting might offer a silver-lining opportunity to redeem some of this year's setbacks.  

The strategy allows investors to sell securities at a loss in order to offset those losses against capital gains taxes on other securities.   

"If you've invested in a total return bond fund anytime in the last five years in a taxable account, you're likely at a loss between 12% and 15%," D.J. Tierney, senior portfolio strategist at Schwab Asset Management Solutions, told Bob Pisani on CNBC's "ETF Edge" on Monday.  

"You have this opportunity before the end of the year to sell that fund, realize the loss, [and] stay invested by buying an aggregate bond ETF," he said.  

Tierney explained that the strategy can be used across asset classes, such as emerging markets, bonds and equities, to lower tax obligations and investment expenses on an ongoing basis.  

"This is the perfect year to do this," Dave Nadig, financial futurist at VettaFi, said in the same segment. "With ETFs, the only thing you really need to be careful of is [that] you can't go exactly the same." 

That means ensuring the funds you are selling and buying while tax harvesting aren't identical exposures, Nadig said. The guideline known as the wash-sale rule prohibits selling an investment for a loss and replacing it with the same or a "substantially identical" investment 30 days before or after the sale.   

"But you could absolutely sell your S&P 500 fund and buy a Russell 1000 fund," he said. "You can get away with that all day."

Nadig explained that while it's difficult to pinpoint whether the harvesting strategy is amplifying in the ETF space, he said VettaFi is seeing more aggregate moves out of big blocks of ETFs.  

"We had big outflows in some of the value funds last week," he said. "We've seen big inflows into really core exposures like an IVV or a VOO. Those things to me smell like tax-loss harvesting." 

Tierney said he is also perceiving levels of increased interest in the strategy among ETF investors, pointing to telltale signs among advisors and clients at Schwab.  

"We're getting questions on strategies and tactics and how to do it," he said. "And then on a macro level, the massive inflows into ETFs in aggregate compared to the outflows in mutual funds would suggest this may be happening." 

With the S&P 500 down about 17% this year, ailing investors can still sell off losing assets of up to $3,000 from their regular income before the end of the month. In turn, losses above $3,000 can be carried forward to offset earnings in future years. 

But Tierney pointed out that the $3,000 cap is only a limitation against offsetting ordinary income.  

"If you've got material gains that you've realized through some other investment this year, then the losses can offset that 1-for-1 and there is no limit," he said. "It could be hundreds of thousands; it could be millions of dollars, if you had capital gains to offset." 

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