Sue Thompson: Early last month, I spoke with financial advisor Mark Balasa about how he approaches tax loss harvesting for his clients. Mark, a principal at fee-only wealth management firm Balasa Dinverno Foltz LLC in Itasca, Ill., mentioned how he looks all year long, every 10 days, for harvesting or rebalancing opportunities
At the end of our last interview, Mark mentioned how people often think about tax loss harvesting only on the equity side of the portfolio. Mark also wanted to point out that there is opportunity for tax loss harvesting related to bonds as well.
So I decided to interview him again and delve a little deeper into his philosophy for using bonds for tax loss harvesting. Here are excerpts from our conversation:
Q: The last time we talked, you had mentioned that people may not be thinking about tax loss harvesting with respect to bonds. What’s the opportunity there?
A: People often have a whole range of bond products in their portfolios – from high yield to international to mortgage backed to traditional Barclays Aggregate holdings. Depending on what happens in the bond market, you could easily have losses somewhere in the bond part of your portfolio, depending on when you bought the holdings and what happened. If you have such losses, you could sell your individual bonds (being sensitive to the size of the bond and the spread) or bond funds to harvest the losses.
Q: In light of how fixed income is performing lately, many bond investors may not have losses this year related to fixed income. Do you have any sense for where investors could be looking for losses?
A: There are certain parts of the bond market that have done just fine this year where there isn’t much of an opportunity, but other parts, such as emerging market debt or even high yield, have been very volatile with potentially more opportunities. Whether there are opportunities or not also depends on when you bought the holdings, what your basis is and how frequently you harvest losses.
Q: When you tax loss harvest with bonds, how do you reinvest?
A: We try to reinvest in a different bond mutual fund or ETF that has a similar duration and credit quality to what we sold, so the portfolio exposure stays the same.
Q: Do you think about tax loss harvesting differently for individual bonds, bond mutual funds or bond ETFs?
A: Each has some of its own peculiarities that you need to be sensitive to. Probably the most difficult to use for tax loss harvesting is the individual bond. And municipals don’t really give much of an opportunity for tax loss management because of the nature of munis. You also need to be sensitive to the spread on the bonds. You can’t really do tax loss harvesting if you have small individual bond holdings because the cost of the spreads would make it cost prohibitive.
Q: Based on the difficulty of tax loss harvesting for individual bonds, have you found that you’re trying to encourage your clients away from individual bonds?
A: We are. Prior to the Lehman bankruptcy, we used individual municipals and corporates for a lot of our larger clients. Post Lehman, we’ve kept our existing positions and let them wind down as they come due, but we are not replacing those positions with individual securities for the foreseeable future.
Q: Some clients love the security of clipping the coupon. How have you been able to get your clients comfortable with the way bond mutual funds and ETFs work?
A: With typical investors, there tends to be a lot of confusion and a lack of understanding related to the bond side of the portfolio. With those investors who do have some understanding of bonds, there is a bias towards individual securities. They say: “If I have a bond, I don’t care about all your mumbo jumbo of up and down and back and forth. I know what its worth. I know what I paid for it. I like that certainty. You can’t give me with that a mutual fund or an ETF.”
Q: So what do you tell them?
A: Our approach is to acknowledge that yes, it is true that there is no interest rate risk if you hold a bond until maturity, but probably the most compelling argument we make is looking at the total return. We show clients the total return of a fund versus an individual bond or bond ladder, including periods over rising interest rate cycles, and then usually clients say “Oh, oh, ok, I get it now.”
The information and examples provided are not intended to be a complete analysis of every material fact respecting tax strategy and are presented for educational and illustrative purposes only. Tax consequences will vary by individual taxpayer and individuals must carefully evaluate their tax position before engaging in any tax strategy.
Neither BlackRock Institutional Trust Company, N.A., nor SEI, nor any of their affiliates are affiliated with Balasa Dinverno Foltz LLC.
This is not meant to be investment advice. The information provided here may not be representative of the experiences of other individuals and does not guarantee future performance.
Bonds and bond funds will decrease in value as interest rates rise.
When comparing bonds versus mutual funds or ETFs, it should be remembered that management fees associated with fund investments are not borne by investors in individual bonds. For differences on mutual funds and ETFs, please click here.
Sue Thompson, CIMA® is Head of the Registered Investment Advisor Group and 401(k) Sales, overseeing the firm’s iShares efforts with registered investment advisors, independent broker/dealers and asset managers.
Prior to joining Barclays Global Investors (BGI, which merged with BlackRock in 2009) in 2007, Sue was a principal at Vanguard, heading the national sales team focused on national full service brokerage firms. She joined Vanguard in August 1999 as Senior Counsel, specializing in tax law and structured products. Prior to joining Vanguard, Sue was an attorney at Orrick, Herrington & Sutcliffe, LLP in California, specializing in public finance. She received her B.A. in Accounting from the University of Washington and J.D. from the University of California, Davis. In addition to holding her Series 7, 63 and 24 FINRA licenses, Sue is also a C.P.A. and holds her Certified Investment Management Analyst (CIMA) designation through the Investment Management Consultants Association in conjunction with the Wharton School at the University of Pennsylvania.