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November 03, 2022 at 11:36 AM
What You Need to Know
- So often, we encourage clients to hold during a down market, making it difficult for them to comprehend when we finally tell them to sell.
- Harvesting losses can offset future taxes while keeping the client invested in the long-term strategic investment plan.
- Explaining this benefit to clients, however, is a difficult task.
The year 2022 will be remembered as an amazing year in the markets … for creating tax losses.
Bucking the usually reliable correlation concept, this year has been down for almost all asset classes. As advisors seeking to bring value to a client during this brutal year, we can proactively collect losses to reduce their future tax bill on investment gains.
The process is a routine and straightforward part of portfolio management. But relaying this benefit to clients is a more difficult task.
When markets are down and client account values are down, we teach them that patience pays dividends. We encourage clients to invest for the long term over a full market cycle. And most importantly, we preach for them to hold when quality investments are down due to macroeconomic events.
Yet we also want them to understand the benefit of selling at a loss to harvest capital losses. This is seemingly contradictory guidance for an abiding client who is willing to heed our advice and hold on for the long term. When we call and say it’s a good time to harvest losses, which means we are going to sell investments, it’s difficult for our clients to comprehend.
The Tax Logic of Portfolio Losses
As a formerly practicing Certified Public Account, I confidently harvested losses this year. I then called clients to update them, excited to inform them of this positive proactive move.
But the reaction from the client was rarely what I expected. It was often confusing with the most common question being “why are we selling when you always tell me to hold for the long term?”
To answer this question, try to explain in simple and logical scenario A or scenario B choices.
“Mr. and Mrs. Client, you can either have (a) negative performance in-line with the negative performance of the markets or (b) negative performance in-line with the negative performance of the markets and have a tax asset that will save money on taxes in the future.”
As an experienced financial advisor, doesn’t that logic make sense? Yet we have so successfully trained our clients to not sell in down markets that confusion, concern and the following comment often comes: “Wait, what? You sold my investments. I thought we don’t sell during these times?”
You can try using more technical language. Explaining that a portfolio can be sold to take losses and still stay invested in a consistent long-term strategic allocation.
