Ask An Ex-Banker: Tax Loss Harvesting

Q. We have a number of investments through Vanguard – small, mid and large cap, some real estate and bonds. All have low costs. Our advisor (from another provider) recently suggested we rebalance, moving some small and mid-cap to large-cap funds. She said we should do this via “loss harvesting.”  I have tried to read up and look at the funds online to figure what funds would be smart to sell.  But the information provided is confusing (and seems to change) and it seems somewhat complicated. Any advice on how best to proceed such as what metrics to base the decision on?

B. Dempsey, San Antonio TX

A. The goal of tax loss harvesting is, through a careful series of sales, to offset some gains you might have from selling an asset with losses you might incur in the same calendar year. Losses that offset gains can leave you with a smaller tax bill. This is especially relevant if you have highly appreciated assets, or assets that were gifted to you that were bought at a much lower price. (Having a “low basis” in investment lingo.)

That’s the theory. 

Tax loss harvesting is easiest to understand on individual stocks.  Let’s say your Google stock appreciated by $50K based on where you sold it and you owed $7,500 on the gains because of the 15% long term capital gains tax rate. And then let’s say you also sold Pepsi in the same year, and you lost $10 thousand between where you bought it and where you sold it. The $10 thousand loss on Pepsi can be netted against the $50 thousand gain on Google if the sales occur in the same year. The result: you are only taxed 15 percent on $40 thousand in capital gains, and your tax bill drops by $1,500. Which is cool. 

But frankly it isn’t probably as important a factor for your long term net worth than the decision in the first place to own, or not own, Google or Pepsi. And in what proportions, and for how long.

The biggest choice is the investment itself, not the taxes

As always when people decide to get clever about saving on taxes, my very strong instinct is to remind them that taxes are the tail, stocks are the dog. Do not let your clever tax strategy (the tail) determine your investment asset allocation (the dog).

You can do this same netting of gains and losses on short-term stock holdings as well, which usually incur a higher tax rate since short term capital gains taxes match your income tax rate. Probably something above 15 percent.

If this seems confusing so far, I think that’s a good sign you don’t want to do it on your own and you may either need to hire an advisor or deputize your existing advisor to do it for you. 

I’m usually somewhere between skeptical and opposed to introducing investment complexity and additional advisors to one’s investment life, so I’ll try to offer a bit more about the narrow set of situations you might consider this for, as well as ways to accomplish this over time.

Tax loss harvesting is something you’d only do in your taxable (non-retirement) accounts, since it’s supposed to address the potential problem of capital gains. You won’t ever pay any capital gains in your tax-deferred retirement accounts.

I think it’s also worth saying up front that the most tax-efficient strategy you can do with your taxable investment portfolio in every case is: never, ever sell. 

Under current law, assets you never sell produce no capital gains taxes at the time of your death for you or your heirs. While your advisor is suggesting you “do something” (rebalancing) and then “do another something” (tax loss harvesting) as a result, my instinct is usually to tell people to “do nothing,” especially if you want to be tax-efficient. 

If you do go ahead and reposition your portfolio anyway, it becomes relevant at the end of the year in which you might pay capital gains to think about whether other sales you can do might produce tax-offsetting losses. 

In 2023, it would not have been surprising if you had losses in your bond portfolio, for example. Individual securities that went down from the time you bought them would be other candidates for locking in losses, although I again would not advise selling something just “for the taxes.” 

As for tax loss harvesting by selling a small-cap or medium-cap mutual fund, that seems too difficult for an individual to undertake on their own. You probably need to engage with an advisor if you want to do that, and that’s going to cost you money, which will raise the issue of whether a tax loss harvesting strategy is overall worth it. (more on that below) 

Another skeptical note, from me: Does incurring taxes by selling your existing low-cost mid-cap and small-cap index funds, and then doing tax-loss harvesting after the sales, truly improve your portfolio? In most market environments indexes of different capitalization are very highly correlated, so you are getting questionable improvements while upping your tax bill and maybe upping your management fees? 

There are at least two other ways to rebalance in a more tax efficient way. One would be to direct new purchases from the bond interest payments and stock dividends into larger cap funds. It would take a longer period of time but without any capital gains taxes. Another would be to just decide any new purchases go into large caps, but without selling the existing positions. A third way is to make the reallocation through changes to your non-taxable portfolio (like within a retirement account), as that doesn’t create a tax bill. Obviously I don’t know the positions of your portfolio and I don’t know your specific financial situation. I’m just a skeptical guy asking whether this advisor is really helping, or is this advisor making suggestions that just look like they are helping?

Going slightly beyond your question, there also exists the relatively new idea in investment management of actively tax-loss harvesting your existing taxable portfolio, not for rebalancing but specifically for tax efficiency.

Brokerages offer tax-loss harvesting strategy as a service within a portfolio that can act like a mutual fund. Fidelity for example offers something that should offer the performance of the S&P500 index, but at any given time they buy and sell individual stocks in ways that minimize capital gains taxes through tax loss harvesting. Since they charge 0.2 to 0.4 percent for this service, they would need to deliver some after-tax outperformance.

Fidelity and other brokerages offer tax-managed investing. For a fee, of course.

An academic research study from 2020 suggests that a tax loss harvesting program like this could save between 0.8 and 1.08 percent per year on your portfolio.

Since tax loss harvesting adds complexity to your investment life, I think it only becomes relevant if you have a large – probably multi-million dollar – taxable portfolio. 

At that scale, paying an advisor to generate an additional estimated 0.6 per year on your taxable portfolio may make sense.

A version of this ran in the San Antonio Express News and Houston Chronicle.

Post read (48) times.

Shit Sandwich – Variable Annuities

In my favorite movie of all time, Rob Reiner recalls the two-word alliterative review of Spinal Tap’s unsuccessful second album “Shark Sandwich,” as simply “Shit Sandwich.’

The band members react to this shocking review with resentment, but also with a sense for what newspapers are allowed to actually say.

David St. Hubbins: “Where’d they print that?”

Nigel Tufnel: “That’s not real!”

Derek Smalls: “You can’t print that!”

Which bring me to my two-word review of an extremely popular ‘investment’ product known as the variable annuity. For variable annuities, I’ve got the same two-word review: “Shit Sandwich.”

Variable annuities deserve the same two word review: “Shit Sandwich”

They Can’t Print That

As I wrote this, I knew the newspaper I write a column for wouldn’t carry my real review of variable annuities.1

Of course they won’t let me print a traditional four-letter word. But, for the record, I really don’t think scatology is why most media “can’t print that’ when it comes to my review.

No, they really ‘can’t print that’ because insurance companies are really important media advertisers and variable annuities are really profitable for insurance companies. Hence, you will rarely see an honest review of variable annuities in traditional media.

I’ve been a faithful reader of the Wall Street Journal for nearly twenty years. They are the best daily newspaper when it comes to finance. Just about every three months or so the ‘Retirement’ or ‘Investments’ section of the Journal has a special on annuities, including ‘variable annuities.’ Alongside these sections of course are a slew of brokerage and insurance company advertisements. (If you didn’t already know, that’s the point of these special sections. This is the nature of the Financial Infotainment Industrial Complex.)

That’s where the fun begins. The writers of the Wall Street Journal are smart, and they are also commercially sensible, by which I mean they know where their bread is buttered. So they do this funny tortured-writer’s dance when describing variable annuities. “New annuity guarantees raise questions,” mumbles one ambiguous headline, or “They’re changing our annuity!” writes another, in which, buried in the heart of the article, we learn of many things that can go wrong with these things, without the writer coming out and saying the one thing he or she clearly knows, which is “stay away from variable annuities if you plan on having enough money in retirement.”

Up until this point I haven’t really explained: What is a variable annuity? Also: why should you care?

I’ll start with the second question first. You should care because an overwhelmingly large number of people who don’t know any better have followed their investment advisor/insurance broker/retirement specialist’s advice and bought this shit sandwich, to the tune of approximately $660 Billion. And this overwhelmingly large number of people plan to use it as a main vehicle for their retirement. Don’t know if you have one? Check your retirement plan. Do you use an insurance company for your investments? If yes, chances are, sadly, you bought one of these.

But back to the first question:

What is a variable annuity?

The insurance companies claim that a variable annuity is an investment product that offers both things that every investor wants, namely ‘safety’ plus ‘good returns.’ The variable annuity appears to offer ‘safety’ via a guaranteed income in retirement. The variable annuity also appears to offer ‘good returns’ by adjusting the guaranteed income upward if stock markets do well during the investment period of the variable annuity.

Ok, so…safety and good returns sounds pretty nice…What’s the problem? The biggest problem is extraordinary fees. Like, probably, all-in fees of 3.5 percent per year on your portfolio, which is a serious drag on your money (but great for the insurance company!)

All appearances to the contrary, insurance companies are really not magical wand-wavers that offer the mythical unique combination of safety and good returns. They pretty much just invest your money in stock and bond markets (plus real estate and some derivatives I guess) just like you can directly, except instead of offering you the actual returns of the blended portfolio you bought, they offer you the returns of a blended portfolio minus decades of huge fees. A really dumb combination of stocks and bonds invested over decades will beat a similarly-invested variable annuity every single time. Because of the fees.


Other problems

There are some other problems with variable annuities which I’ll list here for completeness’-sake.

  1. Once in a while, but more often than we’d like, insurance companies totally miscalculate variable annuity payouts and throw themselves into receivership (a kind of bankruptcy for insurance companies.)
  2. State insurance regulators know this, so they really like to see heavy fees to accompany these products, to keep up the capital base of insurance companies, to avoid receivership. That’s not good for you.
  3. The other way insurance companies avoid receivership is to change the rules governing payouts after you’ve already bought in to the variable annuity. Yes, they do this, and that’s not good for you either.
  4. States typically charge a special tax on payouts from variable annuities, possibly to compensate states for that future receivership problem. Also not good.
  5. You owe ordinary income tax (meaning, top tax rates) on variable annuity income. Regular investments in taxable accounts, held for over a year, offer better tax treatment than this.
  6. Variable annuities are roach-motel investments. You can get in easily, but it’s hard to get out, typically unless you pay hefty “surrender charges” if you try to get out within a 5 or 10 year “surrender period.” This is, basically, unconscionable. My advice: Just make like the French army,2 take the pain, and move on to a better investment.
  7. Variable annuities come to you accompanied by unreadable documentation, incalculable payouts, and small-print ‘disclosures.’ Nobody buying into these things can actually explain to themselves how they work.3
  8. That lack of understanding includes your insurance broker. Ask him some time to explain, in plain language, why this is a better deal than a simple blended portfolio of stocks and bonds. Whatever his moving lips appear to say, the real answer is “my fat commission,” which runs about 5 percent of the amount you invested.

As I’ve written here before, I don’t sell any investment product for a living, and no investment company or insurance company is paying me, so I don’t benefit whether you follow my advice or not.

Variable annuities are good for the insurance company because they make excessive fees from them. They are good for your insurance broker/retirement specialist because of the commission.

Good for the insurance company and great for your broker. Not good for you. But hey…

They are not good for you. But hey, as Meatloaf sang, “Two out of three ain’t bad.”

Newspapers of the world: I challenge you to print honest reviews of variable annuities.

But as Derek Smalls said, “They can’t print that.”



A version of this post, without the scatological reference, and with a toned-down version of my critique of how the Financial Infotainment Industrial Complex really operates, ran in the San Antonio Express News.


Please see related posts:

Very simple, final word, on how to invest

Stupid Smart People

Guest Post: The Simplest Investing Approach Ever

Insurance Part 2 – The Good The Optional The Bad

Insurance Part 1 – Risk Transfer Only




Post read (1093) times.

  1.  I’m not so much concerned with the vulgarity. (Although my editor was!) After all, let’s talk truth for a moment: you can’t read the national or international news section of any ‘respectable’ daily paper without worrying that your curious ten year-old will glance over your shoulder and ask you for definitions of ‘beheadings,’ or ‘pedophile,’ or ‘systematic rape.’ I mean, we’ve got worse problems than a little scatology.
  2. Surrender immediately, obviously
  3.  Except apparently this guy at who offers, for an initial $150 fee, (and who knows after that, maybe more?) to analyze your variable annuity and give you a ten page report on all of its features, pluses and minuses. I don’t have any ties to the service myself, I only saw it referred to in the WSJ, but it strikes me as a good idea for people already stuck with these roach motels. Also, note the fact that if you need a ten-page report to describe your investment product then that investment has violated the “Keep It Simple, Smarty” rule of investing.

Audio Interview with Wendy Kowalik, Part I – On Fees

Wendy Kowalik of Predico Partners

Here’s Part I of my interview with an investment consultant who charges advisory fees in an unusually (admirably!) transparent way. Click on Part II and Part III to hear Wendy and I discuss the uses of insurance, the psychology of savings, and how to get rich slow. You can read the transcript but as always I recommend the audio version highly!


Michael: Hi, my name is Michael and I used to be a banker.

Wendy: Hi, Michael. Wendy Kowalik, I founded Predico Partners. We’re a financial consulting firm.

Michael: Wendy, thanks so much for talking about that. There’s lots of different interesting things to say about your business, but I wanted to start with costs, because I think cost is one of those topics people don’t know that the most important thing to ask your investment advisor, in my opinion, is “how do you get paid?”
You have a different cost structure than most investment advisors. Can you tell me about that? and then I may jump in as well about that.

Wendy: Absolutely. What we found over the years is that most typical cost structures are built where someone brings you assets, and you’re going to charge a fee to oversee them, and invest them, and that’s how everyone gets paid. There’s a thousand different pieces of the puzzle beneath that.
What we decided to do at Predico is to go about life a bit differently. We decided we’d do an hourly charge for clients because it didn’t matter how much money you had; it was more about the time we were spending to either help you find someone to manage your money, or help you find some place to take care of it from there.
We do it based on a project fee or hourly fee.
In 2008 we had a client that had lost a lot of money, when we were in the former investment management business. And one of the things they sat back and asked was: “Do you get paid to keep me in the market or do you really believe that if I get out of the market that you could still make money and help me out?”
We decided we wanted a conflict-free answer to that question. And as we also looked at it, we had clients asking us “If our value went from 10 million to 20 million dollars are you really doing that much work for me than you were doing when it was at ten?”
The answer was no, from our perspective.

Michael: That is the main question. It’s basically as much effort to manage somebody who’s got 100,000 dollars, a million dollars, or 10 or 100 million dollars. As a manager, the scalability of charging fees on assets is so freaking amazing that it’s really unusual that someone would say I’m going to charge — you’re charging analogous to an attorney or a CPA, who would say charge me for the project by the hour, not on percentage of assets. It’s very unusual.

Wendy: Correct.

Michael: It’s almost to the point of you’ve chosen the hardest way to try to run your business, versus the scalability of “Hey, if I get a couple clients who have ten-million bucks I’m pretty much in business and I’m good.” As an investment advisor, it’s a very scalable business that way.

What should be on every investment advisor’s wall

Wendy: That’s a very true statement. I tell clients that all the time. If you look at investment advisors they have two ways of making money. The first way is the way they’re going to market to you, which is “I make money if you make money. I grow my practice by growing your assets. That’s why we should do it this way.”
The other way is the way that most of the investment business works is I make money by getting as much assets under management as possible, so even if a market goes down, if I picked up four more clients with assets, my income has still gone up this year.

Michael: And you haven’t chosen either of these awesome ways to make money!

Wendy: for 17 years of my career I did, and I did that, and we made a really good living by managing peoples’ money, and selling them insurance. I found it wasn’t a comfortable model for me. I was uncomfortable that I was either overpaid for my time for certain clients, and underpaid at other times. I decided I just wanted to get paid for my time, in a manner that both of us could see clearly the only person writing me a check was the client. And yeah, it’s definitely a much tougher model to track your hours, but I think it’s the fairest model, and I can sleep at night when I put my head on my pillow.

Michael: A client writing a check, versus what everybody else does in the investment management world, which is I just quietly slip out a portion of your money on an annual or quarterly basis, and you never even feel the pain of losing that money. When somebody has to write a check upfront for advice they’re given, it’s just a much higher hurdle.
I think it’s sort of magical the way that most investment advisors sort of slip the money out quietly, and you never notice it.

Wendy: Very true statement.

Michael: It’s magical little part of the compensation scheme that we call investment advisory, and you’re not doing it.

Wendy: And what they teach you over time when you’re in the investment management business is “It’s going to be just like gym-membership fees. Everyone signed on to the gym, they never go, and the gym keeps collecting it.” Same thing with an investment advisor.

Michael: Neglect is a key part of a lot of business strategies, gym fees, and a lot of insurance is built around the idea of neglect. You’re not going to re-check.
On a side note, my wife and I were looking at her mutual fund choices this week, and I noticed she’s got a bunch that are fine choices in terms of risk, but they’re probably five times the fees as probably she needs. It’s been going on for ten years. I looked at it and I said, “Oh my gosh, I can’t believe you have these high-cost mutual fund fees.” She said, “You’re the one who told me to do it.” I was like “That’s right, ten years ago.” I’ve neglected for ten years to check whether she’s still in these high-cost mutual funds. There’s a lot of money involved, even at our scale, that over time those mutual-fund managers have earned, simply from neglect. I just forgot to check.
Meanwhile, I’m out there pounding the gavel for people “You’ve got to be in index funds, or lower your costs, and don’t overpay these managers.” Meanwhile, my wife’s retirement account is paying a lot of fees, and I’m the one to blame, as she pointed out correctly.

Cobbler’s kids have no shoes

Wendy: “It is the cobbler’s kids” [“that go barefoot,” I guess] That is a very true statement It is amazing how easy it is to ignore, and it makes you realize how tough it is for clients to do it. There are many times clients say “I can’t believe I’ve let this go on. I’m so embarrassed I haven’t looked at this, or I didn’t know.” We all run into the same point. You’re busy making money for the company’s bottom line. The last thing you look at is your own bottom line.

Michael: It’s hard. I know you know — I don’t, but you’ve done this; it’s hard to get somebody to say pay me money now, upfront, for some future benefit, rather than “I will keep getting paid on a renewable, quiet, stealthy fee, year after year after year.” I admire it. I’m amazed, actually.
Wendy: Thank you. It was definitely — I was very concerned about it when I launched the model because that was what most people told me. I just don’t know that I’d be comfortable, but I found people really like the fact I have no conflict, that I can sit in a room with an investment advisor and help them interview, and ask the questions because we did sell it for 17 years. I really do know why they’re being shown a certain thing or why not. It is fascinating to see all the things that are second nature, after you’ve been in the business, that you wouldn’t even think to tell a client, and watching that evolution come out.

Michael: Somebody comes in to you and they have a modest 50,000 or 100,000-dollar portfolio versus somebody else comes in and they say “I just inherited 15 million,” are you charging essentially very similar amounts for the same service?

Wendy: As I tell everybody, we charge $250 an hour and we’ll sit down and estimate the number of hours to get you an ideal project fee. So, yeah, in answer to that question. If you want us to go through, the only difference should be if you only have 50,000 dollars and two managers, helping you review it and ask some of the questions is a lot less hours, so it should be a lot less charge than it would be if I’ve got 32 accounts.

Michael: Somebody comes to you and you’re going to put together a plan. They may certainly end up paying mutual-fund or hedge fund management fees, and then they may end up paying fees to an insurance solution on top of what they paid you. They’re not eliminating that. It’s just they’re getting that presumably without the conflict of your caring, in a sense, about who they go to. Is that accurately said?

Wendy: Right, we do not manage money so once they actually decide they want to go put that money to work, we’ll help them find somebody if they need help or we’ll review what their current investment advisor is proposing. But yes, they’re going to end up paying some form of fee. The goal is we’ve helped them negotiate those fees down as low as possible, or we help them find somebody that they feel very comfortable, and trusting that they’re in good hands if they’ve never done this before.


Please see related posts:

Do you need an Investment Advisor? And Why?

Management fees – My Hyundai Elantra analogy

Book Review – A Random Walk Down Wall Street, by Burton Malkiel



Post read (1017) times.