Rapidly Rising Market Nonetheless Yields Loss-harvesting Opportunities
PGIM Custom Harvest shares views on the ever-evolving tax-loss harvesting landscape & how direct indexing can help investors capture stronger after-tax returns.
VOLATILITY TO BOOST TAX-BENEFIT OPPORTUNITIES
Jul 16, 2024
Investors with substantial gains after the recent equity rally seeking to mitigate volatility and enhance after-tax returns may benefit from direct indexing.
Stocks rocketed higher throughout the first half of 2024 as major global market averages hit all-time highs, with U.S. markets taking the lead. The S&P 500 Index has doubled over the past five years, including significant gains this year fueled largely by a slowdown in inflation combined with intense enthusiasm for artificial intelligence stocks. Following this runup, stock market investors are likely sitting on some substantial gains.
OPPORTUNITIES IN RECENT MARKET STRENGTH
The robust overall stock index returns have yielded lower-than-average tax-loss harvesting opportunities over the past 18+ months. Since the rally began in October 2022, market volatility has been low, yet underlying component-level volatility (e.g., stocks, sectors, and countries) has provided some tax loss-harvesting opportunities—however limited—for direct indexing strategies. As direct indexing seeks to provide index-aligned pre-tax returns with tax-loss harvesting benefits, investors employing the strategy may have been able to improve after-tax returns.
HARVEST LOSSES FREQUENTLY TO MAXIMIZE TAX BENEFITS
Since the stock market’s long-term trend is upward, it’s important to capture losses when the market provides them. Not surprisingly, tax-loss harvesting opportunities tend to be greatest when markets experience a drawdown and often coincide with peak market valuations. Most recently, the two largest intra-year drawdowns were in 2022 (–25.4%) and 2020 (–33.9%)—periods in which direct indexers may have seen above-average tax-loss harvesting opportunities.
Even when markets rise, underlying losses tend to be regularly available, although the magnitude and the quantity harvested depend on several factors. The principal factors include volatility and dispersion among the index’s components, along with the frequency of portfolio monitoring and tax-loss harvesting. Investors who consistently and systematically harvest losses, such as within the trading day, may experience improved loss-harvesting opportunities relative to those who harvest losses only at year-end. Unrealized losses may dissipate if not harvested in a timely manner.
CALENDAR YEAR PERFORMANCE BY MARKET ENVIRONMENT
Robert Holderith
Head of PGIM Custom Harvest
Investors using a direct indexing strategy may lessen the sting of a market drawdown and prepare for a potentially larger tax bite by using tax-loss harvesting to offset gains, helping to generate better after-tax outcomes.
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The S&P 500 Index is an unmanaged index of 500 common stocks of large U.S. companies, weighted by market capitalization. Indices are unmanaged and are provided for informational purposes only. Investors cannot directly invest in an index. Past performance does not guarantee future results.
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