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Financial Planning > Tax Planning > Tax Loss Harvesting

How to Help Clients See the Benefits of Tax Loss Harvesting

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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.

You can teach that while no two funds are exactly alike, mutual funds and ETFs invested in a specific sector or industry can be very similar. Often we can identify two funds with marginal differences in the underlying holdings.

For example, not all U.S. technology funds are the same, but there are surely some whose holdings are similar enough to produce immaterial differences in performance and exposure. Knowing this, “Fund A” can be sold and on the same day “Fund B” can be purchased.

While they are not the exact same investment, you can comfortably educate your client that their overall allocation and strategy has effectively remained intact. The result is harvested losses that can offset future taxes while keeping the client invested in the long-term strategic investment plan.

Calming Clients’ Fears

Back to the dilemma of communication. What seems to be an obvious benefit to our clients may not be a psychological benefit if they don’t understand it. And at the end of the day, much of our job is to function as a therapist, listening to our client’s fears and calming them from making a bad decision — like selling when good investments are down.

This brings us full circle. Harvesting tax losses is the correct, proactive move we should be performing as investment professionals. Explaining this benefit to clients, however, is the more difficult task.

Don’t assume they understand what you are saying. Don’t assume they will be excited and pleased at the action. It is just too conflicting of a concept.

Here are some ideas on how to positively impress your client on this issue:

  • Take your time, and have more than one conversation about it.
  • Maintain conviction that in a year when market losses continue to compound, at least you are giving them a future asset.
  • Going forward in time, make sure your clients have a clear memory of the actions taken.
  • Starting with the filing of their 2022 tax returns, point out the losses they get to carry forward as shown on Schedule D.
  • Frame it as a new asset to be added to their balance sheet. This may not change their sentiment yet, as it’s a reminder of the tough year it was.
  • Going forward, these markets eventually will start to produce growth.

Each time a client has a profit you want to take, or their portfolio requires rebalancing out of equities because of stock appreciation, you can have the conversation. “Hello client, you made good money in your investments, and you are paying no taxes on the gains!”

It is then, finally, that your client will fully understand the benefits of your efforts. It is then they will see the value a financial advisor brings to their balance sheet in down years.

Oh, how I look forward to that time. But for now, in 2022, let’s keep harvesting losses by planting tax asset seeds for the future.

Noah Rubin, CFP, MBA, is a managing director–Investments and financial advisor at the Rubin Wealth Management Group of Wells Fargo Advisors in Boca Raton, Florida.

(Image: Adobe Stock)


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