Great article, 4Q!
I'm going to confess to a faux pas from yesterday that never should have happened...and I hope y'all learn from my costly mistake. I wasn't really trying to market time but I ended up doing something similarly stupid.
We were in a position to do a fairly significant (to us)
tax loss harvesting (TLH) in our brokerage account because of how much it appeared the market index would be down before the opening yesterday morning.
In case you don't know, when you TLH, the idea is that you sell a stock or fund to take the loss which can then be used to offset
realized gains when you're preparing your taxes. There are some nuances (like don't do wash sales) but swapping one fund for another and harvesting the loss is the overall intent. You sell what you have at a loss and then IMMEDIATELY buy something that is
not substantially similar with the funds you now have from selling at a loss. Again, done properly, you're effectively just swapping out one fund for another and
are not out anything and you have TLH'd the loss to use at next year's tax filing.
Well, I was seeing what was happening pre-market (markets down 2-3%) and told myself, "Self, today is a great day for TLH'ing!" (My wife and I had even discussed the possibility the night before). So, pre-market, I created a transaction to sell all VTI (Vangard Total Market Index ETF). My thinking was that I would then create the buy-side transaction of nother total market index - one that's
not substantially similar*** and uses a slightly different base index (we have a
list of "pairs" or fund substitutes like this that we use) immediately after seeing the funds were available to use. What I failed to even think about was that I am in Utah, market opens at 7:30am MST and I would be transporting kids to school at that time. It was about 10 degrees outside and snowing so maybe my brain was frozen.
By the time I got back home at 815am MST and was able to do the buy, I had just
locked in a 1.5% loss.
Dumb Dumb Dumb (x1000). Something I KNEW not to do and did it anyway. I broke two of
my own rules: don't do this in the first or last hour of trading day and don't allow time to pass between transactions.
There's always a chance that you lose a little bit if the market is moving fast but if you sell and then a few minutes later buy it most likely won't be very much. Yet, there was a 45 minute gap for me.
But, as I sheepishly texted my wife in the
post mortem: "Lessons Learned" (and then she made me tell her what lessons I had learned
)
Anyway, as part of my penance, I shared this with y'all.
An example of how it should work:
Let's say you own 250 shares of VOO (Vanguard S&P 500 Index) which you bought in June 2021 at $400 for a total cost of $100,000. The S&P falls 10% and VOO is now $360/share and your market value is $90,000 so you have an unrealized loss of $10,000.
You decide to TLH. So, you sell all 250 shares of VOO and have $90K "cash" in your account. As soon as possible (minutes later) you would buy something similar ... but not substantially similar (Maybe VTI - Vanguard Total Market Index) at the market price for however many shares you can buy with $90K. You now have $10K to use to offset gains and VTI and VOO move very similarly so whatever happens.
The key to it all is to not allow any time to pass between transactions (other than getting the confirm that the funds from the sell are now available to use and that usually happens really quickly (a few seconds to 2-3 minutes). Don't market time regardless of what you think the market is doing and don't allow the gap of time.
*** There is some debate about what substantially similar means. You definitely couldn't sell VOO (an ETF) and then buy VTIAX (the exact equivalent in a mutual fund) or vice versa within a 30 day period on either side of the sell. Or you couldn't sell Berkshire B and buy Berkshire A. Doing so would create a wash sale. We track which underlying stocks are being used in our pairs and the base index the fund uses for tracking. If they use the same base index, that would be a really good case for being substantially similar. YMMV and make sure you do your own research on this. IRAs/401ks can't do this but transactions in these accounts (like automatically weekly/monthly investing or re-investing dividends) can create wash sales that nullify the TLH so be careful! Caveat emptor!