It's about as traditional as putting up your holiday themed decorations, having the holiday office party, and exchanging gifts. For investors, tax loss harvesting has been a December tradition for as long as they've been an investor, and to say anything negative about it could make you the Wall Street Grinch. As an investor you should always have data to back up your decision. We'll look at whether the data supports the stated benefits of tax harvesting. (To learn more, read Tax-Loss Harvesting: Reduce Investment Losses.)

TUTORIAL: Investing 101

What Is It?
Not too up on this whole tax loss harvesting thing? Let's say in 2011 you were absolutely sure that gold was going to $2,100 so when it hit $1,900 you pulled the trigger on some shares of SPDR Gold Shares (ARCA:GLD), the most popular exchange traded fund (ETF) that tracks the price of gold. Your call hasn't materialized so you you've lost $2,000 on that position. You're still sure it's going to push through the $2,100 level so you would really like to hold on to it, but you've had a good year and you have $8,000 that are subject to capital gains taxes.

Here's your plan. You're going to take your loss on your GLD position and put the $2,000 against your $8,000 in gains so you only have to pay taxes on $6,000 of capital gains. You know you have to avoid something called a wash-sale rule that doesn't allow you to sell and immediately repurchase GLD so you may put your money to work somewhere else for 30 days and then reinvest in GLD after that. That's tax loss harvesting. (For related reading, see Selling Losing Securities For A Tax Advantage.)

The Problem
Trying to beat the system is often a fool's game and in the case of tax loss harvesting, that may be true. The Wall Street Journal took on the role of the investing Grinch when they looked at how well tax loss harvesting actually works. They found that it wasn't as much of a gift under the tree that some people think.

Tax expert Kent Smetters is a professor of risk management at the University of Pennsylvania's Wharton School and cites a few of the normal culprits that remain a thorn in the side of investors: inflation and tax rates.(Check out Timeless Ways To Protect Yourself From Inflation.)

Because tax loss harvesting isn't removing your tax liability, you're going to pay the taxes sometime in the future. When you sold your GLD position at a loss, you lowered your entry point, or tax basis by $2,000 for the next position you open.

Later on, presuming your call of $2,100 gold comes to fruition, you now owe that extra $2,000 that you harvested in 2011 and you'll pay the taxes on that gain at what could be a higher tax rate and using dollars that are worth less in the future than they are today. All of that, according to Smetters adds up to minuscule savings, if any at all.

The Bottom Line
Smetters' analysis doesn't suggest that all tax loss harvesting is ill advised. Investors along with their financial and tax advisers should instead carefully consider and calculate the potential savings involved in this strategy instead of believing conventional wisdom. (To learn more about tax offsetting strategies, read 7 Year-End Tax Planning Strategies.)

Related Articles
  1. Tax Strategy

    Profit from Art with a Charitable Remainder Trust

    With a CRUT, art collectors can avoid capital gains taxes on the sale of art– while also leaving their favorite charity a legacy.
  2. Investing

    3 Healthy Financial Habits for 2016

    ”Winning” investors don't just set it and forget it. They consistently take steps to adapt their investment plan in the face of changing markets.
  3. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  4. Retirement

    Smart Ways to Tap Your Retirement Portfolio

    A rundown of strategies, from what to liquidate first to how much to withdraw, along with their tax consquences.
  5. Saving and Spending

    What Baby Boomers Need to Know About IRA RMDs

    Mandatory minimum distributions from traditional IRAs and qualified plans cannot be avoided. But there are several ways to minimize their impact.
  6. Taxes

    Free 2016 Tax Preparation! Top Online Services

    A place that fills out and files your taxes free of charge? It's no myth, as long as you have a simple return. Read on to find the top preparers.
  7. Taxes

    Why People Renounce Their U.S Citizenship

    This year, the highest number of Americans ever took the irrevocable step of giving up their citizenship. Here's why.
  8. Mutual Funds & ETFs

    The ABCs of Mutual Fund Classes

    There are three main mutual fund classes, and each charges fees in a different way.
  9. Investing Basics

    5 Common Mistakes Young Investors Make

    Missteps are common whenever you’re learning something new. But in investing, missteps can have serious financial consequences.
  10. Mutual Funds & ETFs

    The 4 Best American Funds for Growth Investors in 2016

    Discover four excellent growth funds from American Funds, one of the country's premier mutual fund families with a history of consistent returns.
RELATED FAQS
  1. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  2. When should my tax refund arrive?

    More than 90% of income-tax refunds arrive in less than three weeks, according to the Internal Revenue Service (IRS). However, ... Read Full Answer >>
  3. How do I file taxes for income from foreign sources?

    If you are a U.S. citizen or resident alien, your income (except for amounts exempt under federal law), including that which ... Read Full Answer >>
  4. Are Flexible Spending Account (FSA) items tax deductible?

    Flexible Spending Accounts (FSAs) are employer-sponsored, tax-favored savings plans expressly for the future reimbursement ... Read Full Answer >>
  5. How Long Should I Keep My Tax Records?

    The Internal Revenue Service (IRS) has some hard and fast rules regarding how long taxpayers should keep their tax records. As ... Read Full Answer >>
  6. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
Hot Definitions
  1. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  2. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  3. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  4. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  5. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
Trading Center