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STA Weekly Report – Tis The Season to Give Thanks and to Tax Loss Harvest

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Tis The Season to Give Thanks and to Tax Loss Harvest
Weekly Technical Comment
Year-End Tax Planning and Financial Ideas
Weekly Snapshot of Global Asset Class Performance
401k Plan Manager  *Updated on 10/23/2018

Time flies so fast that Thanksgiving is already around the corner. This year has been an uneasy one for investors, with the Federal Reserve moving rates higher, trade tensions escalating, and a slowdown in growth momentum taking center stage. As this has occurred, market volatility has risen and many global stock and bond indexes have delivered negative returns. Therefore, it is not uncommon to find some unrealized investment losses within a diversified portfolio. While these “paper losses” are certainly not a pleasant experience, investors should consider taking advantage of tax loss harvesting opportunities. Tax loss harvesting is a practice of realizing a loss to offset a gain or income, thereby reducing the current year’s tax obligation. Tax-loss harvesting often occurs in December, with December 31 being the last day to realize a capital loss.

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A capital gain or loss is the difference between the cost basis and the sale price. Usually the cost basis is what you paid for the investment. Any gain or loss is not realized until the investment is sold. There are two types of gains and losses: short-term and long-term. Short-term capital gains and losses are those realized from the sale of an asset held for one year or less. Long-term capital gains and losses are realized from the sale of an asset held longer than 1 year. Short-term capital gains are taxed at marginal tax rates on ordinary income. The top marginal federal tax rate on ordinary income for 2018 is 37%.

Long-term capital gains tax rates on the other hand are 0%, 15% or 20% depending on your taxable income and filing status. Regardless of your tax bracket, tax rates for long-term gains are generally much lower than those for short-term capital gains.

Source: Fidelity

As a part of prudent investment planning, tax loss harvesting can effectively reduce the tax-drag on a portfolios performance and provide a way to improve after-tax returns. However, to accomplish this the strategy must be implemented correctly.

Source: Charles Schwab


For example, Mike has a $1,000,000 portfolio held in a taxable account. By the end of 2018, Mike has recognized $100,000 worth of long-term capital gains. Without making any further transactions, Mike has a capital gains tax liability of $15,000, assuming his long-term capital gains tax rate is 15 percent. The good news for Mike is that tax loss harvesting can reduce this liability. For example, Mike might sell some stocks and bonds that experienced $50,000 in losses. If he sells those securities, the net gain can be reduced from $100,000 to $50,000. In this scenario harvesting tax losses would save Mike $7,500 in taxes.

According to the tax code, short- and long-term losses must be used first to offset gains of the same type. But if losses of one type exceed gains of the same type, then excess losses can be used to offset the other type. Therefore, the most effective tax loss harvesting strategy is to apply long-term capital losses to short-term capital gains. In the previous example, if Mike’s $100,000 gains are short-term and taxed at 37%, harvesting the same $50,000 in losses would save $18,500 of the current year’s tax liability.

As you can see from this example, a tax loss harvesting strategy needs to be carefully implemented. When selecting securities that have lost value for sale, investors need to be mindful not to deviate from their target asset allocation and diversification strategy. Most investors may choose to repurchase the same investment to maintain the proper asset mix. However, they must be careful of wash sale rules, which prohibit repurchasing a “substantially identical” security within 30 days before or after selling date.

It is important to note that the tax savings from tax loss harvesting in a given tax year can overstate the true gains. Selling an investment at a loss and subsequently using the proceeds to purchase the same or similar security effectively resets the cost basis at a lower value and increases the imbedded tax liability. If the security repurchased and then sold in the future, investors need to pay the taxes that are being saved today through tax loss harvesting. Put another way, the economic value of tax loss harvesting is largely a tax deferral rather than elimination of tax liability.

However, the postponed tax payment of appreciated securities, is still extremely valuable in many ways.

First, the time value of money tells us that one dollar today is worth more than one dollar tomorrow. For example, if a $10,000 tax payment can be postponed for 5 years, an investor can simply set $9,000 on the side, invest in a 5-year risk-free treasury bond that returns 2% per year, and receive $10,000 in 5 years. So, he effectively pays $9,000 rather than a $10,000 tax in current dollars.

Second, the tax payment is a real cash outflow from an investment portfolio. By realizing a loss, an investor can save taxes in the current year, which increases the amount of capital available for investment. To some extent, this is analogous to a dividend reinvestment plan (DRIP). In a DRIP, the investor does not take quarterly dividend distributions as cash; instead, dividends are directly reinvested in the underlying stock. The power of dividend reinvestment is manifested when it is compounded over long time horizons. Similarly, the longer an investor can defer realization of capital gains and the higher tax rate on capital gains, the more the investor will benefit from tax loss harvesting.

Third, financial assets like stocks and bonds can receive a step-up in basis when an asset is passed on to a beneficiary upon inheritance. The step-up in basis readjusts the value of an appreciated asset for tax purposes and therefore potentially eliminates the imbedded capital gain liability all together.

Fourth, donating highly appreciated securities can be a very tax efficient way to support a philanthropic purpose. A donor not only can deduct the full fair market value of appreciated long-term assets held for more than a year, but he or she avoids paying capital gains taxes on those securities.

Lastly, if capital losses exceed capital gains in a given year, an investor can use up to $3,000 of losses a year to offset ordinary income in future years.

To sum things up, tax loss harvesting is an active investment management strategy that potentially improves after-tax returns by deferring capital gains taxes into the future and increasing after-tax capital for investment today. Fundamentally, it reflects the most basic principle of finance – the time value of money. That is, when you save tax money today (loss harvesting) and pay it later, you maximize the net utility of each investable dollar in your portfolio.

Short-Term Stock Trend Continues to Weaken
We’ve seen the same pattern over the past week as stock prices have started days strong before sliding in the afternoon.

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The daily bars in Chart 1 show the S&P 500 Index falling back below its (red) 200-day moving average on Monday. Today’s selling is pushing the SPX down toward a small price gap formed a couple of weeks ago between 2700 and 2685 (green box). A drop below that gap would signal a likely retest of its late October low. Its 14-day RSI line (top box) is back below 50. Its daily MACD lines (lower box) remain positive but are starting to weaken. That can be seen by the falling histogram bars. The problem with looking at daily charts and their indicators is that they only give us a small part of the trend picture. I believe in adding an analysis of a weekly chart to see which way that’s trending. That’s because weekly indicators carry more weight than daily indicators. And right now those longer range signals aren’t very encouraging.

Weekly Signal Remains Negative

The weekly bars in Chart 2 show the last leg of the S&P 500 uptrend that began in early 2016. And it shows that uptrend weakening. It shows the October price drop falling below its 40-week moving average (red line) by the widest margin in more than two years, and a rising trendline drawn under its 2016-2018 lows. This week’s attempt to regain those two previous support lines is failing. The two weekly indicators in Chart 2 also paint a negative picture that suggests that the nearly three-year uptrend is in danger. The 14-week RSI line (top box) has fallen below 50 by the widest margin since early 2016. In addition, its third quarter peak fell well short of its early 2018 peak which formed a major negative divergence (purple arrow). Weak longer-range signals on weekly charts are simply over-riding any short-term rally attempts. Monthly chart readings aren’t encouraging either.

Monthly Indicators Are Also Weakening

Signals on monthly charts are even more important than on weeklies. And signs of weakness are showing up there as well. The monthly price bars in Chart 3 show the S&P 500 uptrend since the start of 2016. The down arrow in the top box shows the 14-month RSI line also forming a third quarter negative divergence from the SPX price which hit a new record high during September. Both of those 2018 peaks took place from overbought territory over 70, while the early 2018 peak was the most overbought since the nine-year bull market began in 2009. The RSI remains above the 50 line, but has fallen to the lowest level since 2016. The 2018 divergence from overbought territory suggests that the nine-year bull market is also losing upside momentum. The lower box shows monthly MACD lines in danger of turning negative for the first time in two years. That can be seen more plainly by the red MACD histogram bar which has fallen below its zero line (red circle). That means that the two MACD lines are now negative. Since Chart 3 is a monthly chart, however, no signal is final until the end of the month. And a lot can happen over the next two weeks. But the monthly indicators in Chart 3 do suggest that the market’s major uptrend is starting to show some cracks as well.

Weekly Snapshot of Global Asset Class Performance

If you have any questions, please feel free to email me at


STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

Written By: Scott Bishop, MBA, CPA/PFS, CFP®

The end of the year presents a unique opportunity to look at your overall personal financial planning situation.   With factors like the 2018 tax law changes, life changes or just working towards your goals, now is an especially important time to review things.  It is always a good time to see if you are  on-track at your stage in life. Taking what we now know about the new tax law and weaving together all of the other areas of your personal finances is one of the key ways we provide value to you as your trusted adviser. Below are some things we’d like to help you think through before the year ends.

Read Full Article Here



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