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Tax Loss Harvesting & Capital Gains: What ETF Investors Should Know

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  • (1:00) - What is Tax-Loss Harvesting?
  • (6:20) - Best Way For Investors To Minimize Taxes
  • (10:50) - How Are ETFs More Tax Efficient?
  • (14:00) - Risk of Investing in Unprofitable Companies
  • (17:25) - Episode Roundup: Podcast@Zacks.com

In this episode of ETF Spotlight, I speak with Derek Horstmeyer, assistant professor at George Mason University School of Business. Dr. Horstmeyer is also a regular contributor to the Wall Street Journal.

Tax-loss harvesting is one of the popular strategies used by investors to lower their taxes. Dr. Horstmeyer examined the past 25 years of returns for all stocks trading on the New York Stock Exchange and Nasdaq, and found that the impact of tax-loss harvesting can be really significant, particularly in years when stocks have performed well.

What is the takeaway for investors?

The S&P 500 ETF SPY is up more than 24% this year. Strong stock market performance also results in higher capital gains distributions by mutual funds at the end of the year. Mutual funds that have sold their holdings and recorded gains, distribute capital gains to their investors, typically in December.

For mutual funds held in taxable accounts, these distributions create a tax liability and headaches for investors even if they haven’t sold anything. However this is not a problem for funds held in tax-sheltered accounts.

What can investors do to minimize taxes in coming years? How should they decide which investments should be put in tax sheltered accounts and which in taxable accounts?

REIT ETFs like the Vanguard REIT ETF VNQ and high yield bond ETFs like the SPDR Bloomberg Barclays High Yield Bond ETF JNK are better suited for tax-deferred accounts.

In 2018, 62% of mutual funds paid capital gains distributions resulting in tax liabilities while only 5% of ETFs paid capital gains, according to iShares.

ETFs are more tax efficient compared to mutual funds due to the way they are structured. In case of ETFs, creation and redemption are “in-kind” transactions and thus there are no tax implications.

However not all ETFs are tax efficient. Bond ETFs often require frequent rebalancing to maintain their target duration or maturity. Thus, bond ETFs have to pay out capital gains at times but usually capital gains have been miniscule for popular bond ETFs like the iShares Core U.S. Aggregate Bond ETF AGG and Vanguard Total Bond Market ETF BND in the past few years.

We also discuss why Investing in unprofitable companies like Uber (UBER - Free Report) , Peloton PTON and Lyft LYFT is risky.

Please visit derekhorstmeyer.com to learn more about Dr. Horstmeyer’s research.

Make sure to be on the lookout for the next edition of the ETF Spotlight and remember to subscribe! If you have any comments or questions, please email podcast@zacks.com.

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We discuss some smart tax moves investors should consider before the end of the year.


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