Optimized Tax Loss Harvesting : A Simple Algorithm and Framework

When should you harvest a tax loss? Tax-loss harvesting is a strategy used to improve the net of tax returns of a portfolio, where an investor deliberately sells assets that have incurred a loss in order to use these losses to offset current or future capital gains. However, an important unanswered question is at what threshold should an investor harvest a loss. Specifically, the wash sale rule prevents an investor from realizing the harvested loss if they repurchase a security within 30 calendar days of their harvesting sale. Those who wish to realize a harvested loss must remain uninvested in the security for at least 30 days and hence investors ought to be somewhat selective when choosing to harvest. The wash sale rule thus places loss harvesting into a classic risk-reward paradigm, creating a trade-off between harvesting yield and active risk. In this paper we empirically document such a trade-off and provide guidance on when to harvest losses. We offer a rule-of thumb return threshold of -10% when harvesting monthly or -15% when harvesting daily. This rule of-thumb threshold sits on a frontier of efficient thresholds, from which harvesting yield is traded off against active risk. Furthermore, for out-sized positions in a portfolio, we propose and analyze a throttled harvesting algorithm which controls the active risk arising from loss harvesting. Although harvesting efficiency depends on the stock’s volatility and whether harvesting is throttled over time, we find our suggested rule-of-thumb to be a robust choice in a variety of settings