The Financial Compass

In a world hyper‑focused on investment fees, tax efficiency and after‑tax returns oftentimes take a backseat. In our opinion, that is a mistake. It is not about what you make. It is about what you keep.

No one likes to lose money, myself included. However, when life gives you lemons you need to make lemonade. A recent example of life handing investors “lemons” has been the market volatility introduced by the Iran war and its impact on the Strait of Hormuz.

The reason for market stress always changes, but one potential investment strategy remains available for taxable investors—tax loss harvesting. As Vanguard outlines in their Advisor Alpha research, tax loss harvesting can add up to 150bps or more to annualized net portfolio returns.

How Tax‑Loss Harvesting Works

Tax‑loss harvesting allows investors to generate a tax asset by selling an investment at a loss and reinvesting the proceeds into a similar, but not substantially identical investment to maintain market exposure.

Why does an investment being substantially identical matter in the context of loss harvesting? Wash sale rules. These IRS rules outline that you cannot purchase a substantially identical investment 30 days before or 30 days after the sale date. If you accidentally do, a wash sale can remove any benefit you planned to receive from tax loss harvesting.

 Key Benefits:

• Maintains desired asset class or market exposure
• Realizes capital losses to use now and or later
• Potentially improves after‑tax returns without timing the market

 Example of Tax‑Loss Harvesting in Practice

• SELL: Vanguard S&P 500 ETF (VOO)
• BUY: Vanguard Large‑Cap ETF (VV) – same day

✔ Maintains U.S. large‑cap exposure
✔ Realizes a capital loss for tax purposes

Why Is Tax‑Loss Harvesting Important?

 Tax‑loss harvesting helps investors keep more of what they earn in two primary ways:

1. Offsets current‑year capital gains, or reduces other income by up to $3,000/year
2. Creates capital losses that carry forward to future tax years to offset gains from: business sales, real estate transactions or other liquidity events

For investors with equity compensation from work, think about planning ahead for your company’s anticipated tender offer or IPO.

Reddit (RDDT) investors likely needed tax loss harvesting leading up to the IPO to offset sales post lock-up, whereas Figma (FIG) investors may be loss harvesting after the IPO now that the lock-up period has expired and the price continues to fall. For RDDT investors selling pre-IPO it would have meant loss harvesting non-RDDT investments to proactively generate losses ahead of the IPO. For FIG investors selling post-IPO, it could mean investing in a sector ETF with strong enough correlation, like iShares ETF (IGV), until the wash sale rules are met.

This is called proactive planning. Tax preparation, or filing, looks in the rear-view mirror. Tax planning looks into the future. You need both.

How Does This Apply in Practice? A Client Example

Let’s consider a new‑client onboarding for a husband and wife seeking tax planning, investment management, and proactivity. Their previous firm deployed a tactical investment strategy that routinely sold ETFs as markets changed. While tactically flexible, this type of investment strategy creates a hidden tax cost in taxable accounts.

For this client, taxable assets make up the majority of their liquid net worth. To them, the strategy was costly and ate into their after-tax returns. In our opinion, any investor should understand the tax drag of the portfolios they are invested in.

Morningstar measures this tax drag through their proprietary Tax Cost Ratio, which reflects how much of a fund’s returns are lost to taxes (assuming the highest tax rates). Buying and selling funds regularly only adds to that drag.

 Example:

• Gross Return: 10%
• Tax Cost Ratio: 2%
• Net After‑Tax Return: 8%

An S&P 500 Index ETF has a tax cost of about 0.50%, while a private credit mutual fund has a tax drag of about 3.75%. Even if they both have the same returns, the after-tax returns are wildly different.

Where Tax‑Loss Harvesting Comes In

 After onboarding, we worked with the clients to establish a capital gains budget for 2026. This allowed us to begin to implement our investment strategy in a tax‑aware manner. The budget also helps our client avoid tax surprises.

Shortly after rebalancing, geopolitical headlines escalated with the Iran war, markets pulled back, and opportunity presented itself. We harvested losses across select holdings, replaced them with compliant alternatives, and used those losses to offset both short‑ and long‑term capital gains without changing the portfolio’s overall market exposure.

The Financial Impact of Loss Harvesting

 Without Tax‑Loss Harvesting

• Account Value: $100,000
• Short‑Term Capital Gains: $3,000
• Long‑Term Capital Gains: $7,000

Assumptions

• 32% Federal Tax Rate – per IRS
• 3% State Tax Rate – assuming flat 3% tax rate, not state-specific
• 8% NIIT Rate – per IRS
• 20% Long‑Term Capital Gains rate – per IRS

Taxes Owed

• Short‑Term: $3,000 × 38.8% = $1,164
• Long‑Term: $7,000 × 26.8% = $1,876

Total Tax Drag:

• $3,040 (304 basis points)

With Tax‑Loss Harvesting

• Account Value: $100,000
• Short‑Term Capital Loss Harvested: $5,000
• Net Short‑Term Gains: $0
• Net Long‑Term Gains: $5,000

Taxes Owed

• Long‑Term: $5,000 × 26.8% = $1,340

Total Tax Drag:

• $1,340 (134 basis points)

The Difference

• 304 bps – 134 bps = 170 bps, or $1,700 retained by the client.

These clients maintained their exposure across equities, bonds, and alternatives, while simultaneously generating a tax asset that helps them keep more of their own hard-earned money.

Execution Matters

 For busy professionals, entrepreneurs, and retirees, the question you need to ask yourself is, “Do I have the time, and the discipline, to execute this strategy properly?”. Tax and investment planning can sometimes be opportunistic, and you need to be ready to act. Tax‑loss harvesting often requires:

• Real‑time decision‑making
• Market‑hour execution
• Awareness of wash‑sale rules
• Access to appropriate replacement securities

This is where proactive planning and professional oversight make a difference.

Conclusion—Tax Loss Harvesting Needs To Be A Part of Your Investment & Tax Strategy

 If you have been investing since 2020 and regularly adding capital to your portfolio, you have likely had three-four major opportunities to harvest losses. This does not include other market or sector pullbacks we experience each year. If you have not taken advantage of any them, it may be quietly eroding your after‑tax returns. Tax‑loss harvesting is not just about this year—it is about:

• Future tax planning around liquidity events
• Retirement income efficiency
• Long‑term wealth preservation

Federal capital losses can carry forward through all stages of life, until death, while state tax laws vary. This is a financial planning strategy that is underutilized, but as you can see, it can be incredibly powerful.

 Key Takeaways 

1. After‑tax returns are king—it is not about what you make, it is about what you keep
2. Tax‑loss harvesting can offset capital gains & reduce other income
3. Tax losses can carry forward to future years & become a “tax asset”
4. Proactive planning & execution during market hours is not optional
5. Keep wash sale rules in mind when executing the strategy

DISCLAIMER 

The information provided does not constitute legal, tax, or financial advice. Before making any investment or financial decisions, you should consult with a qualified attorney, tax advisor, or financial professional who can consider your individual circumstances.

SOURCES

+ Charles Schwab. (n.d.). Wash-sale rule: How it works & what to know. https://www.schwab.com/learn/story/wash-sale-rule-how-it-works-what-to-know

+ Internal Revenue Service. (n.d.). Topic no. 409, capital gains and losses. U.S. Department of the Treasury. https://www.irs.gov/taxtopics/tc409

+  Internal Revenue Service. (n.d.). Topic no. 559, net investment income tax. U.S. Department of the Treasury. https://www.irs.gov/taxtopics/tc559

+ Internal Revenue Service. (2026). IRS releases tax inflation adjustments for tax year 2026, including amendments from the One Big Beautiful Bill. https://www.irs.gov/newsroom/irs-releases-tax-inflation-adjustments-for-tax-year-2026-including-amendments-from-the-one-big-beautiful-bill

+ Vanguard. (2025). Advisor’s alpha: Clients and their advisors thriving together for 25 years.

+ Morningstar (n.d.). Tax cost ratio.