Do you have losses in your fixed income allocation?
We’re down to the last few weeks of the year and it is important to be aware of tax loss harvesting opportunities that may exist in your portfolio. In short, tax loss harvesting is a great way to reduce your realized capital gains tax exposure. For this newsletter, I am raising two issues.
1. Tax loss harvesting – it’s time to see what needs addressing (the easy part).
2. How to reallocate – what to do with the proceeds (the hard part).
The easy part:
If you are not an expert on tax loss harvesting – don’t worry. It’s not difficult to understand the basics, however, there are numerous details you should be aware of…so measure twice, cut once. I recommend you do some homework and talk to your advisor (tax or financial) to verify your loss harvesting plan. If you need to learn more, here are a few good articles:
https://www.schwab.com/learn/story/how-to-cut-your-tax-bill-with-tax-loss-harvesting
https://www.investopedia.com/articles/taxes/08/tax-loss-harvesting.asp
https://www.fidelity.com/learning-center/investment-products/etf/tax-rules-for-losses-etfs
The hard part:
How should you reallocate the proceeds from the loss? This is where the deep thoughts are.
For equity exposures, folks are usually fine with swapping an equity for an equity. Most investors understand the volatility and risk exposures associated with equities (the risk can be high). If you are a stock picker, or prefer sector funds or broad indices, there are numerous options to consider when dialing your risk up or down when you reallocate your capital.
For fixed income exposures, I think there is MUCH MORE to consider. Bonds have delivered equity-like downside and volatility for two years now. Should investors simply swap a bond fund for another bond fund when tax loss harvesting? Some deep thoughts:
1. It will take years of higher yields and/or extensive rate cuts from the Federal Reserve to undo the damage that occurred in the bond market in 2022 and 2023.
2. In an economic downturn (will there be a recession in 2024?) bonds might be just fine and add value to a portfolio – and could possibly outperform stocks.
3. Don’t lose sight of the fact that cash alternatives (money market funds, short-term treasuries and CDs) continue to offer 4.50% to 5.25% yields.
While bonds are looking attractive today, think twice before tax loss swapping 1:1 into another bond fund. Here are three wide ranging alternatives to consider when reallocating your fixed income exposure:
1. Laddered, short-term treasuries which currently average about 5% yield (and no state taxes on the income).
2. Dollar cost average into some combination of stocks and bonds (while your cash earns 5% in a money market fund).
3. Re-assess your need for bond funds entirely…there are more options than a 1:1 bond fund swap.
The following 5-year chart demonstrates my point…it is a long road back to all-time-highs in these bond funds. Think deeply about bond fund return expectations (they’re low), bond return drivers (income and price) and the purpose of bonds in your portfolio (income and principal protection).
I have used the five bond funds above in newsletters earlier this year. For consistency, I continue to use them as a broad representation of bond funds available to retail investors. The list of the funds is as follows (ticker symbol):
Vanguard Total Bond Market Index Fund ETF (BND)
PIMCO Total Return Fund Class A (PTTAX)
DoubleLine Core Fixed Income Fund Class I (DBLFX)
JPMorgan Strategic Income Opportunities Fund Class A Shares (JSOAX)
iShares Broad USD Investment Grade Corporate Bond ETF (USIG)
Talk to your tax advisor or other professional advisors before making changes in your portfolio. If you want to talk about your portfolio, drop me an email at hello@westernlevel.com. We can arrange a call.