Tax-savvy investors can capitalize on volatile markets by harvesting losses and turning them into tax savings.

Tax management in portfolios aims to reduce investor tax burden by realizing losses in assets that have performed poorly within a calendar year and deducting those losses from income. This process has traditionally been reserved for year-end.

However, investors should recognize that this process can occur year-round. In fact, in any period of market stress, investors can capitalize on negative performance: losses on one security or basket of securities can be realized, and after 30 days the proceeds can be used to purchase securities with similar characteristics.1 This loss can then be used as a deduction on the investor’s tax bill without the need to transition permanently into cash.

In other words, tax-savvy investors can capitalize on volatile markets by harvesting losses and turning them into tax savings.

Looking across markets, it seems that volatility has become a foundational component of investing. Modern equity markets, for example, are structurally more volatile thanks to increased market efficiency and the ability for information to be rapidly spread; the recent empowerment of retail money through online brokerage platforms has enhanced this dynamic. While at present stock volatility is muted, the combination of stretched valuations and all-time-high prices suggests that it may resurface. Meanwhile, fixed income markets, traditionally stable by comparison, have been choppy in recent months as investors try to assess the implications of a strong economy on the trajectory of interest rates.

If markets are indeed set to be more volatile for the foreseeable future, then active tax management can play a significant role in improving outcomes for investors.

From an implementation perspective, the principle of harvesting tax losses is naturally served by a diversified portfolio. This is in part because global equities tend to move in cycles – periods of U.S. outperformance are typically followed by periods of non-U.S. outperformance. More broadly, it is also because global markets very rarely move together.

This fact can work in the favor of an investor looking to harvest losses year-round. If, for example, the U.S. equity market were to rise while international equities were to fall, an investor would be able to take advantage of harvestable losses from their international equity portfolio to offset some of the realized capital gains from their U.S. equity portfolio. This process would enhance the overall after-tax portfolio rate of return while maintaining a balanced allocation. Moreover, the framework could be applied to any pairwise corner of the investing landscape: for example, stocks and bonds, large cap and small cap, or growth and value.

Ultimately, investors should recognize that the challenging backdrop presents an opportunity for alpha generation, both through traditional security selection and through active tax management. As a result, an ongoing, systematic, technology-enabled approach to harvesting tax losses throughout the year may result in a tax savings and improved outcomes for investors.  

1The “Wash Sale” rule stipulates that an investor selling a security cannot buy the identical security or similar security within 30 days, before or after, of the sale date. If they do, tax losses cannot be used as deductions.
JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal and accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.