Real Talk with Rabih: The Pros and Cons of Tax-Loss Harvesting – Episode #396

Not every stock goes up. Luckily, the IRS has approved tax-loss harvesting as a way to help offset capital gain taxes owed from selling profitable assets. So how does this tax strategy work and should every investor be using it? On this episode of the Dentist Money™ Show, Ryan and Rabih get into the nitty-gritty of how to use tax-loss harvesting strategies in your portfolio.

Show Notes
Schwab article
Axios article

 

 

 

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Podcast Transcript

Ryan Isaac:
Hello everybody. Welcome back to another episode of the Dentist Money Show, brought to you by Dentist Advisors, a no commission, fee only, fully comprehensive financial advisor just for dentists. Check us out at dentistadvisors.com. Today on the show, we have a submitted question in article about the illustrious topic of Tax-loss harvesting. What does that mean? When should you do it? How does it help you? When does it not work? What are the things you gotta keep in mind? What are the caveats? Today on the show, we brought on Robbie, the guy who knows all the stuff, and it was my pleasure to spend some time with Robbie and talk about Tax-loss harvesting. If that’s not the nerdiest sentence you’ve ever heard. If you have any questions for us, you can always go to dentistadvisors.com. Click the book free consultation link, and we’d love to have a chat with you, answer your money questions, and point you in the right direction. Thank you for being here and enjoy the show.

Announcer:
Consult an advisor or conduct your own due diligence when making financial decisions. General principles discussed during this program do not constitute personal advice. This program is furnished by Dentist Advisors, a registered investment advisor. This is Dentist Money. Now, here’s your host, Ryan Isaac.

Ryan Isaac:
Welcome to the Dentist Money Show, where we help dentist make smart financial decisions. I’m your host, Ryan Isaac, and I’m here with longtime fan, favorite, human favorite. Robbie, what’s up Robbie? Thanks for being here Robbie.

Rabih Dimachki:
Hi Ryan. How are you?

Ryan Isaac:
Great. I’m fantastic man. I’m excited to do this. Thanks for being back. It feels like you’re becoming more and more regular and one day this will just be your whole own show and then we will be your guests.

Rabih Dimachki:
Oh, I can never fill those shoes. I’d rather be with you here enjoying our time. [laughter]

Ryan Isaac:
Yeah, man. So today’s episode is… It comes from a… Well, it’s a pretty common question, because it’s a fairly common practice, but it comes from a client who emailed an article about Tax-loss harvesting. We’ve done that a few times on this show, but this article… And then, there’s another one that you actually liked as well, and we could share these too. We could put them in the show notes so people could go read these as well. But the article, if I’m not mistaken, that was shared, was written from the perspective of like, it made it sound really appealing, which it can be, but from the perspective of some kind of instant added gain or dollars in the account or something that felt like an instant kind of benefit, instead of maybe more… A delayed tax one. But that’s what we’re gonna talk about today. So I guess the big overall questions and we’ll dive in would be, what is Tax-loss harvesting? Why does it matter? When is it applicable? When is it not applicable? I wanna talk about those kinds of things. Anything else top of mind for you that you wanna hit in today’s episode?

Rabih Dimachki:
Oh, no, I think those are great places to start because if we start from there, I have a feeling that is gonna get technical and we’re gonna drift and talk about even bigger and more interesting stuff. So let’s start with these. I’m looking forward.

Ryan Isaac:
Let’s start there. So recap the article, what was… What I sent it to you, I said, “Hey, a client sent this to me. It’s a good topic to discuss, especially coming off of a year.” I mean, we’re recording this in, what are we now, May, 2023. Coming off of 2022, where we did have losses and an opportunity to really kind of dive into Tax-loss harvesting. This is a good question. What was the tone of the article that you took though? What was your… How about summarize it? What was your takeaway from it?

Rabih Dimachki:
It’s a good article. It actually highlights the value of a Tax-loss harvesting strategy to our portfolio, that some people, especially because it’s targeting retail investors, it’s highlighting a value that they might not be aware of. And it’s very important for your portfolio for it to be tax sensitive and tax aware and try to drop taxes whenever the opportunity rises. The article starts by talking about Tax-loss harvesting is, which we’re gonna get to in a second. And then, it continued with some marketing about the robo advisor and how much they’ve harvested for the year.

Ryan Isaac:
Yeah. Okay. Well, let’s just start there. What is Tax-loss harvesting? What does it mean?

Rabih Dimachki:
Tax-loss harvesting is a tax strategy, not an investment strategy. It’s a tax strategy that exists, thanks to how the current tax code is set up. So it’s not something related to an investment know-how. If they change the tax code, this might go away, but the premise is just like how you pay a gain whenever you make a profit. If you are losing and you make a loss, you should get some taxes back. And this is very helpful in investments because there are so many ups and downs. Volatility is high and there are always… Even if you’re the best investor in the world, there will always be positions in your portfolio that are losing. That’s… And like…

Ryan Isaac:
That’s a full… Hold on, I’m sorry to cut you off there, but that’s kind of a funny point. There will always be positions in your portfolio that are losing. This is probably… That’s probably a whole other subject and episode, but I don’t think people realize that in a well-built account, maybe in the most well-built accounts, that’s probably especially true. That’s diversification. If you’re diversified, then there’s always something that you’re gonna be unhappy about. That’s a whole other subject. But I just think that’s kind of funny thing that you just said, ’cause it’s so true.

Rabih Dimachki:
That’s right. And I think another point, that it’s very important to mention, is that if your actions, where you’re trying to harvest those tax losses, changes your risk profile, this is not Tax-loss harvesting anymore, because you can look at any losing position in your portfolio and say, Oh, I have losses on it. I’m gonna sell out and cut my losses. And then just so I don’t look like a bad investor, I’ll tell people, Oh, I’m cutting my losses. I’m Tax-loss harvesting. This is not what Tax-loss harvesting is. If you are exiting a position, if you are changing your investment strategy, you’re just thinking to the losses. There are tax benefits of that, but that’s not Tax-loss harvesting.

Ryan Isaac:
Yeah. Along these lines of the specifics, let’s clarify what kinds of accounts can this even happen in. Can you do this in a 401k, in an IRA? What accounts does this actually have? Where is this meaningful? What kinds of accounts?

Rabih Dimachki:
It’s only meaningful in accounts where you are gonna be responsible from a tax perspective when the trade happens. So you can trade in a 401K or Roth IRA or an IRA in that sense. And you will not incur any taxes unless there’s a distribution when you now reach the age limit. However, when you are trading in a trust, a corporate account, your brokerage account, your joint account, the moment you do the transaction, there are tax consequences. Whether it was a gain, or a loss that you will have to report when the fiscal year ends and you have to file your taxes.

Ryan Isaac:
It is kind of interesting from a behavioral, again, this, I’m like… My brain goes in so many tangents, but from a behavioral standpoint, it’s really interesting is watching 15 years of hundreds and hundreds of dentists investment behavior, people don’t really do active trading in their IRAs and their 401Ks almost ever. There’s this mental barrier where people are like, That’s later money. And they don’t do active trading, but when people have brokerage accounts, that’s where they try to do all of their active trading. And it’s kind of funny, ’cause it’s like, from a tax perspective, that’s counterintuitive as well, when people are trying to time markets, jump in, jump out, own maybe individual holdings or something. It’s funny that in the most tax efficient accounts people never do… People just buy and hold in 401Ks all day long. But in the brokerage account where it’s actually… There’s consequences that have to be realized that tax year when there’s an action, that’s where people take all of their… That’s where they do all of their trading. When they’re doing that, that way, it’s kind of an interesting behavior thing.

Rabih Dimachki:
It is. But I still think it’s the right behavior. You really don’t wanna actively trade in your IRAs, right?

Ryan Isaac:
No. Well, you don’t wanna do them anywhere. I guess that’s my point.

Rabih Dimachki:
And you’re brokerage as well, correct?

Ryan Isaac:
Yeah, that’s my point. You shouldn’t be doing it anywhere. If you’ve got a sound strategy, you shouldn’t be actively trading. But in the play… If you’re going to, it’s funny people never do it in the tax efficient place. Okay. So we’re talking about after tax accounts, trust brokerage accounts, anything where if you sell something and you have a gain or loss in that sale, you will have a tax consequence in that calendar year. That’s what we’re talking about. I think there’s a… When people… I don’t think a lot of people know about Tax-loss harvesting and just my anecdotal experience is that when people hear about it they almost react like, wow, that seems like a pretty advanced strategy, that maybe nobody does or no one is aware of. It always seems like news to people when they hear about it, which does… Which isn’t surprising, ’cause this stuff is hard to learn, I guess, unless you’re purposely trying to learn it.

Ryan Isaac:
But I think there’s misconceptions around it though too, because when people first learn about it, a lot of times just from the questions I get or the comments I get about it, it’s almost like there’s this impression or perspective that it’s an ongoing thing you can do constantly no matter what the market and the cycle is and what’s going on. And it’s like if you’re a smart investor or investment manager, then you’re always Tax-loss harvesting. So can we talk about some of the logistics about when it works, why it works when it works, and then when it does not work and when it does not apply?

Rabih Dimachki:
Yeah, sure. We can start by describing the trade that actually goes on because this is gonna be very helpful to tell you when it works and when it won’t work.

Ryan Isaac:
Yeah, yeah.

Rabih Dimachki:
With Tax-loss harvesting, let’s assume you’re in a globally diversified portfolio, which we breach, and you have multiple exposures and your US exposure, FED raised interest rates last year and whatever holding you had that represents your US portion of the portfolio went down. In that situation, if you look at your cost bases or account statements, you’ll see that I’m losing on this position, but you do not want to change your risk exposure and you want to stay invested in the US. So what you end up doing is that you sell that tray, that holding, that represents your US and you go out in there in the market and you find another holding that will have a very, very, very similar risk exposure representing the US. So what ends up happening is that you will sell the losing position, you’ll buy another position, however, your risk exposure maintains, stays constant throughout the whole trade, and as the US recovers, you would’ve captured those losses at the bottom and rode the fund as the market recovers. So that’s the trade that happens. And as you can see, it has a place where you sell and a place when you buy. And does this always happen in the market? I think Tax-loss harvesting is a lot like going fishing or in your situation with the surfboard behind it.

Ryan Isaac:
Okay.

Rabih Dimachki:
Going surfing, right?

Ryan Isaac:
I’m listening.

Rabih Dimachki:
You need the Waves or you need the fish to bite. It’s not gonna happen anytime. And that good wave or that good bite is a drop in the market and if the market isn’t dropping, your holding is not gonna show any negative basis from a tax perspective. So selling it might actually incur gains and you don’t want that. So you’d want to hold it for a longer period of time. But if that holding is losing money and you want to stay in that risk exposure, right? You would sell out of it, go into a different fund, get, harvest those losses and maintain your risk exposure. But there are caveats for that. There is a Wash Sale Rule, there are…

Ryan Isaac:
Can you talk about those?

Rabih Dimachki:
Yes. Okay, so let’s start by the thing that, we are not CPAs over here and a Tax-loss harvesting strategy requires a follow up from the CPA to actually materialize those tax benefits that are incurred through the trade, but…

Ryan Isaac:
Because… Let me just say, at the end of the year, what happens is the brokerage, the bank, like TD Ameritrade will send out a statement, it’ll show gains and losses for the year. You give that to your CPA when you file taxes. That’s when you’ll take the gains and pay taxes on them, or that’s when you’ll take the losses and apply them against different types of income. That’s what you mean by you’ll get the forms and then work with your CPA on actually how to realize those things on your taxes. Yeah.

Rabih Dimachki:
That’s right. So the first point we mentioned is that you need to see a drop in the market and an actual hit to your basis for a tax-loss harvesting to make sense. The second point is that there’s something called the Wash Sale Rule, which is a regulation that prohibits people from abusing this opportunity in the market as whenever you have a losing position, you’re gonna get taxes back. The wash-sale rule simply means that if you sell a security at a loss and you go and buy the same security again within a 30 day period, that loss is not gonna be counted and is gonna be added back in terms of bases that you’ll have to incur later on. So buying, within those 30 days, the same security might actually negate all the effort that you’ve put in. And the IRS even goes a step further where it’s like any identical “security” might trigger that wash-sale rule. So you don’t actually have to sell Apple and buy Apple, you can sell Apple, something very, very, very similar and it’ll trigger the wash-sale rule. So, over here you’ll have… It’s a little bit of experience, trial and error to see what would be flagged, what would not be flagged, and…

Ryan Isaac:
‘Cause they don’t just give you a list, right? They’re just not giving you a list, they…

Rabih Dimachki:
No, they…

Ryan Isaac:
They have a vague set of rules and you just have to try your best to follow them.

Rabih Dimachki:
Yeah. They have three metrics, the IRS has three metrics. If it’s in the same issuer, that’s the first red flag, if the top 25 holdings are identical, that’s another flag, and the third one, if they shared the same strategy. So if you’re going from one S&P 500 ETF to another S&P 500 ETF, and for example, they are from the same issuer, that’s the big red flag.

Ryan Isaac:
So isn’t that hard to do… And maybe you’ll get to this, so don’t stop your train of thought. But my question is, isn’t this hard to do when… This seems really easy to do when you’re holding individual stocks. But this seems harder to do when you’re just building an index-based kind of portfolio globally diversified index fund type of portfolio, like switching one index to another. ‘Cause if I get out of the US position, I don’t wanna just be gone from it, I want more US, but those rules seem like they kind of… They take a lot of my options off the table.

Rabih Dimachki:
Yeah, they might. Luckily, the ETF landscape has been expanding widely. And so far, we, advanced advisors, do Tax-loss harvesting at an ETF level for our clients.

Ryan Isaac:
Yeah, sure.

Rabih Dimachki:
And it’s been working pretty well and you are able to work within the bounds of what’s legal and that’s very important.

Ryan Isaac:
Yeah, yeah. Totally. That’s… Well, it helps when you have a Robbie on staff, whose running all this stuff.

[chuckle]

Rabih Dimachki:
Thanks.

Ryan Isaac:
That’s why you’re there. Okay, finish your train of thoughts. So we were at wash-sale rule, there was a few other things you’re gonna mention that can… That are like caveats to doing this.

Rabih Dimachki:
That’s right. So first point, they need the proper market environment, a dip. Two, there are legal conditions that you should work around, like the wash-sale rule. And three, there are the costs. The more trading you incur in a portfolio, the more trading costs happen. In the old days when people used to trade mutual funds, you’d have to pay a commission on the trade and you will actually see how much I’m paying, those are called explicit costs. When now they tell you it’s zero commission trading, it is free in a sense, but there are implicit costs that whoever wants to trade their account should be aware of. The biggest one of them is the difference between debit and ask. When market conditions are doing pretty well, you are trading within market hours, there’s plenty of liquidity in the market. The bid… And the difference between the bids price and the asks price, Which is called the spread, is usually very minimal, so a round trip between two ETFs is usually minimal in terms of the cost of the trade. However, if we said you need a dip in the market for tax-loss harvesting to make sense, during market turmoils and when there is volatility, that bid asks spread widens, and it widens significantly that doing a round trip in a thinly traded ETF, might cost you a couple percentage points of the money you’re moving around.

Ryan Isaac:
Geez. Geez.

Rabih Dimachki:
So implicit costs are very important whenever you are trying to do a time sensitive trade.

[pause]

Rabih Dimachki:
Part of the article, the original article, that you were talking about, had a specific emphasis on technology doing this, robo-advisors doing this kind of trading. Do you know if that technology pays attention to some of these? I know they follow certain rules of like wash-sale rules, but do you think they pay much attention in the parameters, maybe in the algorithms to make sure costs don’t get out of control? I mean, they probably do, I’m sure it’s easy to do. I’m not a programmer or a CPA, as you mentioned before. But that is kind of the human element too of just knowing the client and knowing the situation and being like, “This is not worth it. We don’t want to take this kind of a implicit cost hit right now.” Do you know how the robo side works, if it takes that kind of stuff into account?

Rabih Dimachki:
Yeah, as you mentioned, the main Trade-off is between the cost of the trade and the tax losses harvested. Usually robo-advisors… Well, it’s an amazing technology and there’s a lot of future and in making people’s life easier. Even professionals trading on BlockDesk, we use a lot of… A new software that has these algorithms in it, but it’s still not there to completely replace a human making the trading decisions. And the reasons are for that, if you look at the current algorithm for how a robo-advisor works, it tells you those are the ETFs or stocks that I’m gonna buy, and those are the ones that I list as equivalences in terms of Tax-loss harvesting opportunity arises. And the way I determine whether a Tax-loss harvesting opportunity is there, is by looking at the percentage drop that happened to a certain security. If it dropped by 2% or 3%, or if the portfolio shifted away from its allocation, then I’m gonna go and trigger that rule.

Ryan Isaac:
Yeah.

Rabih Dimachki:
It literally works on rule-based information and numbers. So, it’s not looking at the market like, “Is the shift in the market happening because the Fed is raising rates? Or is the shift happening because there’s a global pandemic?” Like what is causing…

Rabih Dimachki:
The shift in the allocation and the loss and in the initial investment in the position. And because they don’t have that awareness, I think here’s the thoughtfulness of when a human is trading. A human might wait away a day or two because, most of the indicators in the market, most of the sentiment is showing that the sell off is gonna continue, whereas a Robo-advisor will trade every single day because each day it’s its crossing those internal quantitative thresholds that are being set.

Ryan Isaac:
Sure. Yeah.

Rabih Dimachki:
So when Robo-advisor is overreacting to a news, because it’s out passing all those thresholds, it incur more costs in executing a Tax-loss harvesting strategy than what a human would do. And yeah it’s not about just selling or continuously rebalancing your portfolio, it’s more about how do you do it in the most efficient way. And maybe when AI and Robo-advisor unite, they will be better than advisors. But so far, most academic literature has been that there is a value that is… A value comes with the intentionality of the person trading. And so far, the mixture between human and machine has been superior to only having one person alone too overwhelmed to do anything, and a machine that’s only following rules that do not gain insights from what’s happening around in the system.

Ryan Isaac:
They don’t… The rules of the machine don’t pass the sniff test of the human. That, again, another topic, but that’s why when all the robo-advisors were born, created, everyone thought it was just gonna end the whole industry, and then fast forward to today and all the cost have of quadrupled and they involve humans in it, which I think is cool because I think we’re learning that machines alone or humans alone, we’re better together, better with a buddy, better with a robot buddy.

Ryan Isaac:
Okay, so as you’re talking, if I’m hearing you say some of this stuff for the first time, as you’re talking about watching your portfolio for a certain position to have a loss, I think a question in my head would be, “Well, does this mean I watch it every day and every time there’s a little loss, I do this, or do I wait for there to be a certain percentage loss, or does it have to be a loss over weeks and months?” Do you literally watch for losses and harvest every single day? According to the wash watch sale rule, you would probably run into troubles replacing your securities within a fairly short period of time if you’re doing it too often. So is there any rule of thumb for how… How sustained the loss needs to be? Is it a few days, a few months before you’re like, “Okay, this is a logical place to take the loss and find an equivalent?”

Rabih Dimachki:
Yeah, sure. And you’re thinking about it the right way. You would look at a the percentage drop in the security value, or a dollar amount drop in the security value. This is one of the metrics that people would look at. Also, and here’s where historical data helps and in for us internally to assess at what level would we want to go in and say we’re harvesting those losses, you would look at the historical drawdown of that individual fund or security. So if it’s an individual stock and you’re trying to, I don’t know, tax loss, Tax-loss harvest between Coca-Cola and Pepsi, because they are companies in the same industry, their risk profile is to a certain extent very similar.

Rabih Dimachki:
You would look at the historical volatility and you know that an individual stock might drop in multi digits. Whereas, if you are looking at a diversified ETF, whether it was something that represents the whole emerging market, you would expect the drawdown to be much, much lower. So the difference in the historical drawdown gives us insights in determining the level where we would say, “Okay, this is our rule of thumb. Beyond an X percent drop, we would go in with the Tax-loss harvesting.” And this is a compromise between what historical data tells us, what the cost of doing the trade is, and you’re just trying to optimize through to the best way to execute it.

Ryan Isaac:
I know we did a lot of Tax-loss harvesting last year, calendar year of 2022, especially in the beginning because the drops were big enough and they were quick enough. Can you give, just maybe looking back, some insight onto some of the harvesting you were doing and why, like certain times during the year it made more sense to do it?

Rabih Dimachki:
Oh, yeah. 2020…

Ryan Isaac:
Oh, yeah. Oh, yeah, the old ’22.

Rabih Dimachki:
[chuckle] 2022 was very interesting because stocks were reacting, but also bonds fell down. And usually when you’re talking about Tax-loss harvesting strategies, you’re only thinking of the volatile asset class, which is equities.

Ryan Isaac:
Yeah, stocks. Yeah.

Rabih Dimachki:
But last year we were on steroids. We had bonds that were going down, you could tax loss, Tax-loss harvest from these, and you got stocks that were going down.

Ryan Isaac:
Crazy.

Rabih Dimachki:
So there were ample opportunities and I’d say we were Tax-loss harvesting every 2-3 weeks, because we wanted the loss to accumulate for it to make sense for the trade. And I’d say 99%, or 90% of our clients all had losses harvested from their accounts. Here’s the difference when a client you would harvest for them and a client that you wouldn’t. Some clients they do not actively save in their portfolios. They will…

Ryan Isaac:
I was just gonna bring up this point. Yep, go ahead.

Rabih Dimachki:
It’s right?

Ryan Isaac:
Yep.

Rabih Dimachki:
So for a client whose last deposit in into their portfolio was in 2018, the drop in 2022 was not big enough to deplete the gains that were accumulating since 2018. So if you look at their Cost basis and their statements, their positions are not at… They’re not making a lot of money because there’s been a drop. The percentage accumulation increase and in the price isn’t that high, but it’s not in a negative territory. Whereas our other clients, and they are mainly of the younger cohort who are actively saving each month, they have had multiple opportunities where they would be buying at the high between quotations and the market would drop. Since we now acknowledge the volatility, acknowledge that there will be times where you’re gonna be at buying at the high and we don’t wanna exit that risk exposure, we would tax loss, Tax-loss harvest there where we would be changing their holdings, and…

Rabih Dimachki:
Yes, for our clients who have monthly drafts or quarterly drafts, those were the clients who received the most benefit from the Tax-loss harvesting that happened in 2022.

Ryan Isaac:
I’m glad you brought that up because I was gonna say, I think a lot of people just assume when there’s a drop there’s a harvesting opportunity but you just said it, if the money’s been in there long enough, even a big… Even last year was a bear market drop and it wasn’t enough to wipe out gains over the previous few years if people had put in money long enough. But because the vast majority of our clients are active monthly savers, most of them, some of them bimonthly or is it biweekly? Is it one that’s every other week? Is that biweekly or by monthly? We don’t know.

Rabih Dimachki:
Yeah. We’ve even have weekly people.

[laughter]

Rabih Dimachki:
So we have weekly.

Ryan Isaac:
Yeah. Most of our clients are frequent savers so during 2022, like you said, that new money had a chance to take on losses. The older money… And I think that’s a discrepancy I’m glad we brought up, I wanted to talk about. Because I think that’s a misconception people have, that just because there’s a loss in the market or a drop in the market does not mean there’s a loss in your account based on how long your account’s been around and how old the money is that’s been sitting there.

Rabih Dimachki:
So yeah, for those clients, which is most of our clients, who are frequent savers, yeah, a big opportunities to do that. I’m glad you brought that up. That was on my mind the whole time. [chuckle] Okay. So when I sent you this article, you also sent a second article back to me that you felt… And we’ll, put a link to all this stuff again here. The two are from… I guess you could name them two too. One of them is from Schwab and the other one… I think the one that was sent to us was from Axios…

Rabih Dimachki:
That’s right.

Ryan Isaac:
Was it? Yeah. And then you found the one from Schwab. What did you like about the way that the Schwab article… What was different between the two that you liked in the Schwab article that you felt was a better education on the subject?

Rabih Dimachki:
Here, the conversation shifts to how you actually reap the reward of all the Tax-loss harvesting that you’ve done.

Ryan Isaac:
Okay. Because, you’re saying, in the first article, it made it seem like you harvest and then you have this immediate gain or cash or something that’s immediately in your hands and it was a little that’s not quite the whole picture.

Rabih Dimachki:
Exactly.

Ryan Isaac:
Perfect.

Rabih Dimachki:
So assuming you have $100,000 in a portfolio and you were able to harvest $8,000, this $8,000 is not going back into a brokerage account and your brokerage account value is not really changing because you are harvesting those losses. When you are harvesting those losses, what happens is that on your cost basis, which is what your CPA looks at, they will see how much gains and how much losses you’ve incurred in a certain tax year. And sometimes they’ll cancel each others, those losses and gains. Sometimes the gains will be higher and you’ll have to pay taxes on them and sometimes the losses will be higher and you can deduct up to a certain amount from your income.

Ryan Isaac:
Yep.

Rabih Dimachki:
So and in the first article, I thought it was slightly misleading because people would think the money would go into their brokerage account. Their money will not hit their brokerage account. Their money, the harvested money, will impact their tax bill at the end of the year. So and in the second article, they made it really clear for an non-CPA like me to really understand the details of it. If you incurred long-term tax losses, those will offset any long-term gains on your brokerage account or a sale of an asset, whether it was a car, a house or whatever. And then any short-term losses will offset any short-term gains and if there’s anything left beyond those, those can two, too, interchangeably mix. And after that, and this is I think the rule, if you still have losses, you can deduct up to $3000, for a married couple, out of your adjusted gross income, right?

Ryan Isaac:
Yes. Yes.

Rabih Dimachki:
And anything beyond that, if you still even have more losses, those can be carried forward for future years. And I think the first two are great. You’re not paying taxes in this year, you’re deducting a little bit of your adjusted gross income but the third point I think is the most important is because you can defer some of the losses for future years. And we know, as compound interest does its magic on portfolios, there will be a time where you’ll have to rebalance your portfolio and rebalancing your portfolio might mean selling your winners that have gains and this will incur a tax gain. So if you’ve accumulated all these tax losses across the years, you can use them in a good years when you have to rebalance your portfolio and you don’t have to pay taxes on it.

Ryan Isaac:
Well, Yeah, thanks for that description. And along those lines, how often, Robbie, do we get requests when dentists need money from their portfolios for something?

Rabih Dimachki:
Mm-hmm.

Ryan Isaac:
Daily? Across hundreds of clients at this point?

Rabih Dimachki:
Yes.

Ryan Isaac:
People need money all the time for emergencies, for opportunities, real estate down payments, growth, expansion, acquisition, taxes they weren’t planning on. I mean, your name it, second homes, boats, whatever… It’s daily. I’m sure you… I mean, not for me as one advisor but across all our advisors, I’m sure it’s a daily request for money. And so.

Ryan Isaac:
That’s right.

Rabih Dimachki:
In a lot of those situations, people are recognizing gains when they’re asking for money and then, yeah, if you have this carry forward from some of these losses during these years, you can offset those. And I think that actually goes back to your previous point from the first article that made it seem like there was is an immediate… If you harvested eight grand, $8000 you just get eight grand $8000 in your portfolio or something. But it’s like, “Well, no. You can harvest those losses and then if you don’t have actually any capital gains that year, you can only take up to three of the eight for that year against your income and you gotta pass either five onto the next year.”

Ryan Isaac:
So it’s a slow trickle. You know what this also reminds me of? This is not exactly Tax-loss harvesting strategy focus but speaking of how often dentists need money, we have to make a decision and help make a decision with them on how they take out money. So if someone says, “I need a $100,000 hundred grand outta my portfolio, down payment for my next building or something,” we have options. And you kind of mentioned this in the beginning, you can go in and say, “Well, what’s the most tax efficient option? What’s the most tax efficient option possible?”

Rabih Dimachki:
But if it’s the most tax efficient, that might change your allocation or your risk profile because we might have to sell things to be the most tax efficient, that bump us from an 80% equity allocation to an 87% equity allocation. Maybe that’s okay. Maybe it’s not okay. Maybe we have to take a higher tax hit and not be as efficient in order to keep the allocation and the risk profile the same. So I don’t think people realize when they pull out money, and also how this relates to what it’s gonna be like in the future when they retire they’re retired, pulling out money every single month, how it really is kind of, there’s some science to it, but there’s an art form as well, like going into the account and realizing like, which they’re called lots L-O-T-S, people don’t, a lot of people don’t know this.

Ryan Isaac:
It’s just like all the shares of the mutual funds and ETFs that you bought along the way all those years, you can pick which lots you’re gonna sell. Do you wanna take losses? Do you wanna take gains? Do you want to be a tax efficient, but like, change your allocation and or your risk profile? Or do you wanna like keep your risk profile the same, your allocation the same, but like not be as efficient with taxes? It’s a very wide open, it’s kind of an art form. And I do think that’s where a human comes in to really understand the situation and help analyze that with them because it can, that can be different month to month for someone who’s pulling out up money one time for a big expense or in retirement.

Rabih Dimachki:
That’s right.

Ryan Isaac:
Not Tax-loss harvesting related, but it’s the same Decision-making process when people pull money from their accounts. Which dentists, I had a dentist that asked ask me once, like, how important is it for a dentist to be liquid [laughter] I was like, I can’t even tell you how often dentists need money for stuff that they didn’t you see coming and they’re so glad that we save money. So if you have anything to say about that, like just commenting on the withdrawal strategy and how that relates to Tax-loss harvesting or keeping allocation the same. Go ahead. If there’s anything to say about that.

Rabih Dimachki:
Yeah, I think you hit all major points. I think I have one more to add. So you’re right. We don’t want the, proverb is as we don’t want the tax tail to wag the dog, right? Yes. So when you are withdrawing money from your portfolio, your number one priority is to maintain the asset allocation because the asset allocation is gonna change your risk, and this is gonna change your return over a long period of time. However, you can take tactical moves if the portfolio is set in a good position. So one of these positions, if you’ve had previous losses harvested, another of this, another position is whether the portfolio has incoming drafts every single month of savings.

Rabih Dimachki:
Because if the portfolio has money coming every single month, instead of liquidating the portfolio in a manner where it keeps everything in balance, your asset allocation constant, we wouldn’t mind deviating away from this to incur a trade that will be more tax efficient. It’ll cost you less in capital gains simply because we know there’s new money coming in Yes. Where we can fill that gap. Yes. And this is, by the way, robo-advisors are really good at choosing the specific lot to try to choose the lots that keep the portfolio in balance, but are the cheapest from a tax perspective. Yeah. But not all robo-advisors up until this day when we’re recording, take into consideration how much new money is coming in and how do you insert the art into the science that you worked on.

Ryan Isaac:
Or you know that we’re doing this, but in three months a house is getting sold and a big chunk of cash is coming back or a business…

Ryan Isaac:
Exactly.

Ryan Isaac:
Like we, you just the human knows the human situation in. Totally. Yeah. Yeah. That’s a really good point. I’m glad you brought that up. I know people are just like overwhelmed with excitement on the topic of Tax-loss harvesting today but I think we covered the main question again that came in was check out this article and it sounds like this is a huge benefit. Can you explain this to me? Are we doing this? So I think we covered that question, but I’m glad we went down some of the other avenues of the caveats, the pros and cons when it doesn’t make sense.

Ryan Isaac:
And I love what you just finished with, tax decisions shouldn’t be the thing that leads the investment decisions. We see that so often. You said don’t let the tax tail wag the investment dog. Is that the right [laughter]? Geez, it gets so confusing. It just means like tax incentives and benefits should be secondary to what is the best investment. And we often talk to clients who try or want to put money into things, not because it’s actually good for them or improves their position or might even be a good investment or that they even understand, but that there’s just a good tax benefit attached to and the tax benefits should be secondary. So I’m glad you kind of ended with that. Is there anything else you would want to say or share about this topic, this exciting mind-blowing topic of Tax-loss harvesting?

Rabih Dimachki:
Honestly, I think everyone should be exited.

Ryan Isaac:
You love it. We love it. I’m excited, you’re excited.

Rabih Dimachki:
Everybody should Excited about Tax-loss harvesting. And honestly, yes if you want to position your portfolio in a way where you can capitalize more on this good wave or this strong bite of a market drop, some, like when the market drops, some people are like, okay, I’m here to buy the dip. Yeah. But when the market drops, there’s also an opportunity tax loss, Tax-loss law harvest. And if you are continuously saving in your account, the probability of you being able to capture that is much, much higher.

Ryan Isaac:
Yeah. I love that. Yeah, great message to end with, if you are a frequent saver, your ability to capture tax efficiencies, but also purchasing cheap, assets without having to predict when they’re gonna be cheap, that’s how you do it. You just save a lot. You just save frequently. If you’re putting money in your 401k every two weeks from a paycheck, you’re gonna catch the dips and you’re gonna, you’re gonna do a great job. So, Robbie, thanks for joining us here today.

Rabih Dimachki:
Thank you for Having me.

Ryan Isaac:
Yeah, as always, man. I’ll let everyone know if you have like an article or a technical question or something about the economy or markets or, something along these lines that you’ve read or heard or have talked about or interested in, just send it over. Email me, ryan@dentistsadvisors.com, DM me, find submit a contact form on our website, whatever. And we’ll I will bring on the illustrious Robbie to come talk to us about it and educate us all. So please send in your questions.

Rabih Dimachki:
Oh I can’t wait.

Ryan Isaac:
Yeah, we’ll just keep it coming. So Robbie, thank you very much and thanks for everyone for being here. And if you have any questions, go to dentistsadvisors.com and we’ll catch you next time on another episode of the Dentist Money Show. Bye-bye now.

Taxes